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What is an Option?

An option is a security, just like a stock or bond, and constitutes a binding contract with strictly defined terms and properties. For most casual investors, that definition may as well be customer right to an option in ancient Greek.

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Put Options and Call Options Perhaps we can explain options a bit more clearly. Then you can either keep the shares which you obtained at a bargain price or sell them for a profit.

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But what happens if the price of the stock goes down, rather than up? You let the call option expire and your loss is limited to the cost of the premium. When you hold put customer right to an option, you want the stock price to drop below the strike price.

If it does, the seller of the put will have to buy shares from you at the strike price, which will be higher than the market price. Because you can force the seller of the option to buy your shares at a price above market value, the put option is like an insurance policy against your shares losing too much value.

You have more rights than you might think

Purchasing options can give you a hedge against losses, and in that sense, they can be used conservatively.

But there are many options strategies that amount to little more than gambling and can increase your risk to a frightening degree.

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Remember, when a call is exercised, stock must be delivered by the seller of the call. If a strong market advance or a major announcement by the issuer has driven the share price up sharply, your losses could be enormous.

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As indicated, many option strategies involve great complexity and risk. For this reason, not all options strategies will be suitable for all investors.

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In fact, with the exception of sophisticated, high net worth individuals who can afford and are willing to incur substantial losses, the writing of puts or uncovered calls would be unsuitable for just about everyone.

Nevertheless, brokers sometimes engage in inappropriate options trading on behalf of customers who do not understand the risks. If you have lost assets because your stockbroker was engaging in options trading, please contact us today.

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Have Questions? Just Ask!

  • Always remember to read and understand the terms and conditions before signing.
  • Your rights when signing or cancelling a contract |
  • Trading options is very different from trading stocks because options have distinct characteristics from stocks.