What are Options?

Options are financial derivative contracts between two parties where the buyer has the right but not an obligation to buy a security or other financial asset at a specified price within a specified period of time.

This simply means that the buyer can choose to go on with the contract only if they will benefit from it. It’s optional to buy not an obligation. And if no longer interested in the contract, they can let go.

This is different when it comes to the seller of the option. The seller has the obligation to carry out the transaction if the buyer chooses to exercise it.

Let’s say, for instance your friend is selling a nice car but you don’t have enough money to pay for it. You negotiate and he agrees to sell it to you if you make a deposit and complete payment in a months’ time.

Suppose the car costed $50,000, the deposit required is $5000, and remaining balance of $45000 to be paid at the end of the month. In the course of the month you land on your dream car being sold at the same exact amount as that of your friends car.

You can choose to purchase your dream car and not exercise the right, it’s not an obligation to buy in the first place but you will have to lose the first money you paid as deposit for booking.

On the side of the seller, if someone else comes offering a higher price for the car, it’s not your problem. You will still pay the same amount as agreed upon in the contract because you have the right.

This example can be related to options.  Trading options you also have the right but not an obligation to exercise them.

Options consists of two parties including the Holder (buyer) and the Writer (seller)

The price at which an underlying security can be bought or sold is known as a strike price. The underlying security is one in which an option derives value from. These include ;

  1. Stocks
  2. Bonds
  3. Indices
  4. Foreign currencies
  5. other financial assets.

Common  terms used in option trading.

Premium

The payment required by the seller from the buyer to enjoy the privileges of the contract.

Strike price/ exercise price.

The pre-decided price at which the asset can be bought or sold.

Expiration date.

The future date on or before which the option contract can be executed. Time at which a trade is closed or settled.

 Lot size

The fixed number of units of the underlying stock that form a single future or option contract.

Open interest

Total number of the outstanding positions on a particular options contract across all participants in the market at any given time.

The major options are;

Call and Put options.

Call option gives the holder the right but not an obligation to buy the underlying asset  at a specified price in the give time. The holder has the choice to exercise his or her rights when he/she feels like.

Put option gives the holder the right not the obligation to sell an underlying asset at a specified price in a given period of time.

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