What are options?
Option, as the word suggests, is a choice given to the investor to either honour the contract, or if he chooses not to walk away from the contract.
Some people remain puzzled by options. The truth is that most people have been using options for some time, because options are built into everything from mortgages to insurance.
An option is a contract, which gives the buyer the right, but not the obligation to buy or sell shares of the underlying security at a specific price on or before a specific date.
To begin, there are two kinds of options: Call Options and Put Options.
A Call Option is an option to buy a stock at a specific price on or before a certain date. In this way, Call options are like security deposits.
When you buy a Call option, the price you pay for it, called the option premium, secures your right to buy that certain stock at a specified price called the strike price. If you decide not to use the option to buy the stock, and you are not obligated to, your only cost is the option premium.
Put Options are options to sell a stock at a specific price on or before a certain date. In this way, put options are like insurance policies.
With a put option, you can insure a stock by fixing a selling price. If something happens which causes the stock price to fall, and thus, damages your asset, you can exercise your option and sell it at its insured price level. If the price of your stock goes up, and there is no damage, then you do not need to use the insurance, and once again, your only cost is the premium. This is the primary function of listed options, to allow investors always to manage risk.
Technically, an option is a contract between two parties. The buyer receives a privilege for which he pays a premium. The seller accepts an obligation for which he receives a fee.