Key takeaways

• An option is a contract that gives its holder the right to buy or sell an underlying asset at a certain price for a limited period of time.

• There are five basic factors of a standard option: underlying asset, premium, strike price, contract type, and expiration date.

Understanding an Option

An option is a contract that gives its holder the right to buy or sell an underlying asset at a certain price for a limited period of time. There are five basic factors of a standard option:

1. Underlying asset. An Option's price is derived from the underlying asset that it tracks. The underlying asset could be stocks, market indices, exchange-traded funds, bonds, currency, interest rates, or futures contracts.

2. Premium. An option premium is a price paid by the buyer to the seller for an option contract, or the current price of an option contract that has yet to expire.

3. Strike price. The strike price is the price at which the holder of the option contract may buy or sell the underlying asset. It is also known as the exercise price.

4. Contract type. There are two types of options: calls and puts. A call gives the buyer the right to buy the underlying asset at the strike price for a limited period of time. Conversely, puts give the buyer the right to sell the underlying asset at the strike price for a specified period of time.

5. Expiration date. An expiration date is the last day that option is valid. On or before this day, the option holder can choose to exercise the option. After that time, The holder no longer has any rights. Based on whether an option can be exercised before the expiration date, there are two types of options: American options and European options. American options can be exercised any time before the expiration date of the option, while European options can only be exercised on the expiration date.