What Are Stock Options?

Options Traders, Options Trading, Options Research, Options Analysis

Stock options are contracts that represent the right to buy (or sell) shares of the underlying equity at a predetermined price, and by a predetermined date.  Stock options are traded in units called "contracts," which are typically based on 100 shares of the underlying equity. For this reason, options are classified as "derivatives," since they derive their value from an underlying asset.

Call options gain value from a move higher in the underlying stock, while put options increase in value when the underlying stock moves lower. However, stock options can be bought and sold in a variety of different combinations, allowing traders to fine-tune strategies to match with their market outlook -- whether it's bullish, bearish, neutral, or somewhere in between.

It's important to note that buying a stock option contract does not obligate you to buy or sell the actual shares of the underlying stock. It only signifies that you have the right (or "option") to buy or sell those shares.

Furthermore, in certain applications, stock options can even be used to hedge other investments -- which means these contracts are useful not only as purely speculative tools, but also as portfolio "insurance" during times of market turmoil.

The expiration date on your option contract might be days, weeks, or months in the future, but this date determines how much time the underlying equity has to move as you expected. Similarly, the price at which you agree to buy or sell the shares -- known as the "strike price" or "exercise price" -- is fixed.

For investors who are more accustomed to trading shares of stocks directly, education is an absolute requirement before transitioning to calls and puts. Even though the value of stock options is based upon the price of the underlying equity, there are several other factors in play that can influence the premium of your contracts.

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