What are options?
Options are contracts that give the purchaser the right, but not the obligation, to buy or sell a security, at a fixed price within a specific period of time. Options are known as derivative investments because their value is derived from the value of the underlying stock (when buying or selling options on stocks) or commodity (when buying or selling options on commodity futures).
Options are traded on a number of exchanges, including the Chicago Board Options Exchange (CBOE) and International Securities Exchange (ICE).
Important Option Terms
Exercising the option - This is the buying or selling of the underlying asset via the option contract.
Strike or exercise price - This is the fixed price in the option contract at which the holder (investor) can buy or sell the underlying asset (e.g. stock).
Expiration date - The maturity date of the option; the option doesn't exist after this date.
Premium – this is the additional cost that one needs to pay in order to have the rights, but no the obligation to buy or sell a security at a fixed price.
Breakeven points - this is the market price that an underling asset must reach for an option buyer to avoid a loss if they exercise the option. For the call buyer, the BEP is the strike price plus premium paid while BEP for put position is the strike price minus premium paid.
American option - can be exercised anytime during its lifetime and not only at its expiration. These normally trade on standardized exchanges.
European options - can only be exercised at maturity/expiration. These tend to trade at a discount compared to American options due to a lower degree of flexibility. European options normally trade over the counter.