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Investing 101: What is a financial option?
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(AP Photo/Richard Drew)
An option gives investors just that, an option – either an option to buy an underlying asset at a future date (a call option) or an option to sell an underlying asset at a future date (a put option). The investor can buy or sell that underlying asset at the price that it was when they bought the option. The underlying asset is usually a stock, index, or futures contract.
An investor buys a put option when they think the underlying investment will depreciate in value so they can sell it at its higher, former price. By that same logic, an investor buys a call option when they think the underlying investment will appreciate in value so they can buy it at its cheaper, former price in the future and then sell it to make a profit.
The issuer of the option is called the option writer, and they receive a payment called a premium for creating the option. If the buyer chooses to use his option, the seller is obligated to sell or buy the asset at the agreed upon price. The buyer of the option may also choose to let his option expire. In this case, the buyer only looses the premium paid to the option writer, and is not forced to use his option if he/she guessed wrong and would lose money by doing so.
An option is a type of derivative security.
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