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: the underlying asset, premium, strike price, contract type, and expiration date.
Understanding
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 contract:
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.
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.
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.
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.
Expiration date. This is the date on which the option expires. If an option has not been exercised prior to its expiration, it ceases to exist— that is, the option holder no longer has any rights, and the option no longer has any value. The style of an option refers to when that option is exercisable. The most common styles are the American style and the European style. The American style option may be exercised at any time prior to and including the day of expiration. The European style option is exercisable only on its expiration date.
