An option contract, in trading, is a financial derivative that gives the holder the right, but not the obligation, to buy (call option) or sell (put option) a specific asset (like a stock, commodity, or currency) at a predetermined price (the strike price) within a specified period of time (until expiration).
There are two main types of options:
Call Option: A call option gives the holder the right to buy the underlying asset at the strike price before or at the expiration date.
This is typically used when an investor expects the price of the underlying asset to rise.
Put Option: A put option gives the holder the right to sell the underlying asset at the strike price before or at the expiration date.
This is generally used when an investor expects the price of the underlying asset to fall.
In exchange for this right, the buyer pays a premium to the seller (writer) of the option. The seller, in turn, is obligated to sell (in the case of a call option) or buy (in the case of a put option) the asset if the buyer chooses to exercise the option.
Options contracts can be used for various purposes, including hedging against price volatility, speculating on price movements, or generating income through writing (selling) options.
It’s important to note that trading options involves a high level of risk and complexity, and it’s not recommended for inexperienced investors. It’s crucial to thoroughly understand the mechanics and risks associated with options before trading them. Additionally, options are subject to time decay, meaning their value decreases as they approach their expiration date. This makes them inherently different from trading the underlying asset directly.