HOW Do OPTIONS WORK?
Buying an option means paying a specified amount, called a
premium, to purchase a contract. This contract gives the holder the right to
buy an amount of the shares on which the option is based at a pre-determined
price, known as the strike price.
The contract may be exercised, which means used to buy the
shares at the strike price, during a period of time which ends on a specific
date. This date is called the expiration date of the option contract.
The option does not obligate the holder to buy the shares,
except if it expires “in the money,” which means that the strike price is
better than the market price at that time.
The holder of the contract can also choose to sell the
contract within the time prior to expiration, and doing so can result in one of
Selling an option contract can either achieve a profit by
garnering a price higher than the premium paid (minus fees), or may be sold at
a loss which allows the holder to recoup some of their initial investment,
rather than waiting until expiration.
If an option contract expires “out of the money,” meaning
that exercising it would mean paying more than market price for the underlying
shares, it expires worthless.
Options are frequently ‘traded,’ which means that they are
bought and sold as a commodity in their own right, not only as a means of
purchasing the underlying shares which their holder is entitled to buy.