Options are contracts between two parties to buy or sell an asset at a fixed price and date
Options are a type of financial derivative. Derivatives get their name because they derive their value from another asset. This other asset is called the underlying asset. Options are contracts and each of the following is specified by each contract;
- Underlying
- Right to Buy or Sell
- Price
- Date of Expiration
Types of Options
There are two types of options, Calls and Puts. Calls give the owner the right to buy the underlying at the agreed price, which is called the strike, at any time before the option expires. So for example if $SPY was trading at $550 a share and you owned a $SPY Call with a strike of $500 you would have the right to purchase shares of $SPY at $500. You could then turn around and sell those shares on the open market for a profit.
Puts work similarly to Calls. The holder has the right to sell the underlying to whomever sold them the option. Because Puts offer a hypothetical minimum sale price for an asset. Buying Puts can offer protection to a long position.
If someone is buying options that must mean someone else (the counterparty) is selling.
When you sell options you have the obligation to buy/sell the option holder’s shares. If you sell a call and someone exercises their right to buy the shares, you are required to sell your shares at the agreed upon price. Similarly when you sell a put you are agreeing to buy shares at the strike.
The reason people are interested in selling options is that they sell the option for cash. This cash they receive is called the premium. This premium can serve as a source of income for portfolios.
Options offer investors a lot of different strategies from hedging to speculation to income. This post is not meant to serve as a comprehensive guide and is just an introduction. Before you make any investment decision, please, do your own research or speak to a professional. Contact us if you have any questions or would like to schedule a free investment consultation.
