An option can be simply defined as an agreement between two parties that allows the buyer to pay money up front for the right to take an agreed-upon action at a later date. The buyer does not have to use his option if he doesn’t want to. On the other hand, the seller has the obligation to hold up his end of the bargain if and only if the buyer wishes.
There are only two kinds of options—calls and puts—and options trading can be as simple as buying or selling a call or a put. However, InvestorsObserver’s option strategies tend to embrace more sophisticated combinations of options trades that drive profits higher while limiting risk. To understand how these strategies work, start at the beginning, and we will build upon the fundamentals of options trading to show you how we use these basic building blocks to create sound investments.
Unlike stocks, options expire. If you buy an option, you have until the options expiration date to exercise your option. Once the expiration date has passed, the option has no value.
Options (calls and puts) and their prices are all tied to the price of the underlying asset, or stock. The cost of the option will depend on how much time left until the expiration date and also how the price of the underlying stock compares to the strike price of the option.
Every standard option contract represents action that the holder can take on exactly 100 shares of the underlying stock.
For simplicity, we will refer to the option buyer and seller throughout the Learning Center. Keep in mind that like many other trades, options trades are cleared on an exchange by a market maker, so if we buy an option we can close the position by selling it on the open market. We are not beholden to the wishes of the trader on the opposite side of our original trade.