OPTIONS DEFINED

What are options?

Options are a financial instrument that provide the investor with ways to use leverage, increase an investment return, or as an insurance against loss. Options can be used to hedge against financial risk or as an aggressive leveraged instrument to increase the amount of investment return.

There are two types of options known as put options and call options. An investor can purchase (buy) an option or sell an option. In any monetary exchange a purchaser pays money for a good or service and the seller receives the money from the purchaser of the good or service.

An option gives the purchaser the choice to exercise a future action at a specific price for a specific amount of time. For this ability to exercise the option the option buyer pays money (premium) to the option seller. Option buyers must be right on the market direction of the underlying stock or index and they must be right on the timing of their option purchase as well as being able to either sell their option contract for a profit before the option contract expires or to exercise their option by purchasing the underlying asset and try to sell this asset sometime in the future for a profit. The option purchaser also has to hope that the sale price of his purchased asset exceeds the option premium he paid to the option seller when he entered his option position.

Future posts will explain the "Put" and "Call" options.