An options contract is an agreement between two parties to facilitate a potential transaction on the underlying security at a preset price, referred to as the strike priceprior to the expiration date.
The two types of contracts are put and call options, both of which can be purchased to speculate on the direction of stocks or stock indices, or sold to generate income.
Learn more about this course. What is an options contract? In this article, Dr Hong Bo outlines what are options, and explains how they offer flexibility to investors. In financial terms an options contract is another type of financial derivative. Similar to a futures contract, an options contract can be used for the purposes of both hedging and speculating.
For stock options, a single contract covers shares of the underlying stock. The Basics of an Options Contract In general, call options can be purchased as a leveraged bet on the appreciation of a stock or index, while put options are purchased to profit from price declines.
The buyer of a call option has the right but not the obligation to buy the number of shares covered in the contract at the strike price. Put buyers have the right but not the obligation to sell shares at the strike price in the contract. Option sellers, on the other hand, are obligated to transact their side of the trade if a buyer decides to execute a call option to buy the underlying security or execute a put option to sell.
Options are generally used for hedging purposes but can be used for speculation. That is, options generally cost a fraction of what the underlying shares would. Using options is a form of leverage, allowing an investor to make a bet on a stock without having to purchase or sell the shares outright.
Call Option Contracts The terms of an option contract specify the underlying security, the price at which that security can be transacted strike price and the expiration date of the contract. A standard contract covers shares, but the share amount may be adjusted for an unusual way to make money splits, special dividends or mergers.
Options Spreads What Is an Option? Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Unlike futuresthe holder is not required to buy or sell the asset if they choose not to.
In a call option transaction, a position is opened when a contract or contracts are purchased from the seller, also referred to as a writer.
In the transaction, the seller is paid a premium to assume the obligation of selling shares at the strike price.
If the seller holds the shares to be sold, the position is referred to as a covered call. Put Options Buyers of put options are speculating on price declines of the underlying stock or index and own what is an option in a contract right to sell shares at the strike price of the contract.
If the share price drops below the strike price prior to expiration, the buyer can either assign shares to the seller for purchase at the strike price or sell the contract if shares are not held in the portfolio. Key Takeaways An options contract is an agreement between two parties to facilitate a potential transaction involving an asset at a preset price and date.
Call options can be purchased as a leveraged bet on the appreciation of an asset, while put options are purchased to profit from price declines.
Buying an option offers the right, but not the obligation to purchase or sell the underlying asset. The call-buyer can also sell the options if purchasing the shares is not the desired outcome. Compare Accounts.