Options Contract Definition

Option type of transaction

The companies whose securities underlie the option contracts are themselves not involved in the transactions, and cash flows between the various parties in the market.

Option (finance) - Wikipedia

Image source: Getty Images. What's a call option?

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A call is the option to buy the underlying stock at a predetermined price the strike price by a predetermined date the expiry. The buyer of a call has the right to buy shares at the strike price until expiry.

The seller of the call also known as the call "writer" is the one with the obligation. We'll discuss the merits and motivations of each side of the trade momentarily.

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What's a put option? If a call is the right to buy, then perhaps unsurprisingly, a put is the option to sell the underlying stock at a predetermined strike price until a fixed expiry date. Investors who bought shares of Hewlett-Packard at the ouster of former CEO Carly Fiorina are sitting on some sweet gains over the past two years.

Options Contract Definition

Why use options? A call buyer seeks to make a profit when the price of the underlying shares rises. The call price will rise as the shares do.

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The call writer is making the opposite bet, hoping for the stock price to decline or, at the very least, rise less than the amount received for selling the call in the first place. The put buyer profits when the underlying stock price falls.

The strike price may be set by reference to the spot price market price of the underlying security or commodity on the day an option is taken out, or it may be fixed at a discount or at a premium. The seller has the corresponding obligation to fulfill the transaction i. An option that conveys to the owner the right to buy at a specific price is referred to as a call ; an option that conveys the right of the owner to sell at a specific price is referred to as a put.

A put increases in value as the underlying stock decreases in value. Conversely, put writers are hoping for the option to expire with the stock price above the strike price, or at least for the stock to decline an amount less than what they have been paid to sell the put.

Closing Transactions

We'll note here that relatively few options actually expire and see shares change hands. Options are, after all, tradable securities.

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As circumstances change, investors can lock in their profits or losses by buying or selling an opposite option contract to their original action. Calls and puts, alone, or combined with each other, or even with positions in the underlying stock, can provide various levels of leverage or protection to a portfolio.

Option users can profit in bull, bear, or flat markets.

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Options can act as insurance option type of transaction protect gains in a stock that looks shaky. They can be used to generate steady income from an underlying portfolio of blue-chip stocks.

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Or they can be employed in an attempt to double or triple your money almost overnight. But no matter how options are used, it's wise to always remember Robert A. Insurance costs money -- money that comes out of your potential profits.

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Steady income comes at the cost of limiting the prospective upside of your investment. Option type of transaction a quick double or treble has the accompanying risk of wiping out your investment in its entirety. The Foolish bottom line Options aren't terribly difficult to understand.

Calls are the right to buy, and puts are the right to sell.

There is an options seller writer and an options buyer holder. The option seller can enter or exit a transaction, and so can an option buyer. Opening Transactions Buy-to-Open This is the transaction the options buyer make to enter a long position on an option.

For every buyer of an option, there's a corresponding seller. Different option users may be employing different strategies, or perhaps they're flat-out gambling. But you probably don't really care -- all you're interested in is how to use them appropriately in your own portfolio.

Next up : How options are quoted, and how the mechanics behind the scenes work. Check out more in this series on options here.

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. 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.

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