Stock Options and Derivatives

A stock option is a privilege sold by one party to the other, giving the buyer the right, however not the obligation, to buy (call) or sell (put) a stock on a prior price agreed upon given a specific date or certain period of time. The option is connected to an exchange index, futures contracts, or a listed stock or real estate. In the U.K., a stock option is termed as a “share option.”

While European options can only be redeemed at the expiration date, American options can be exercised at anytime between the date it was bought and the date of expiration. Most exchange-traded stock options however are American.

Each stock option is designated by; 1) name of the associated stock, 2) strike price, 3) expiration date, and 4) the premium paid for the option including broker’s commission.

There are two popular types of options, the calls and puts. In a call option, it gives you the right (but not the obligation) to buy a stock based on the strike price at any time prior to the expiration date of the option. With this, an option is then worthless and has no value upon its expiration.

Even if people have not owned the options before, they also sell them. When this is done, it is called “writing” options and if you have written a call, meaning you are short a call, you are obliged to sell shares at the strike price at any time even before the date expires when you get called.