Options Trading

An option is a contract that gives the buyer the right (but not the obligation) to buy or sell a specified quantity of a given asset, at a specific price, on or before a specified time. Unlike futures trading, the purchaser of an option is not obligated to buy or sell at the exercise price, and will only do so if it is profitable; if the option is allowed to lapse, the purchaser loses only the initial purchase price of the option (the option money).

The strike, or exercise price, of an option is the specified, pre-determined price at which an asset can be bought or sold if the option buyer exercises his right to do so on or before the expiration day. The price paid by the buyer to acquire the right to buy or sell is known as a premium.

The one who is obligated to buy (in case of a put option) or to sell (in case of a call option) the underlying asset in case the buyer decides to exercise his option is known as the option seller, or writer. His profits are limited to the premium received from the buyer, while his potential losses are unlimited. The premium fluctuates in response to the current market value of the security or exercise price, the time period between the strike and the expiry date, and the supply and demand in the market. The one who buys an option, which can be a call or a put option, is known as the option holder. His profit potential is unlimited, while losses are limited to the premium paid by him to the option writer.