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What is Options Trading (Video)

What is Options Trading (Video)
March 10
22:27 2012

An option is a contract between two parties that gives the purchaser the right, but not the obligation, to buy or sell the underlying asset for a specific price while the seller has the obligation to fulfill their part of the contract. The asset can be any type of security including stocks, exchange-traded funds or other products.

Here is a real life example of how options work: Let’s say you want to buy a widget, but you do not have enough cash on hand to buy it at the moment and you want to negotiate with the seller to have the option to buy the widget within two months at the price of 25,000. The seller agrees and in return for that option asks you to pay 2,000 up front. Two things can happen in the course of two months, the value of the widget can rise above 25,000, in which case if you exercise your right to buy the widget you stand to profit. Or, the value of the widget can also fall below 25,000, in which case you can choose not to buy it, but lose your initial 2,000.

Here is a video explanation.

Options can be bought or sold. A person who buys an option is known as a holder and a person who sells an option is known as a writer. The difference is that holders can chose to exercise their right to buy or sell where as writers are obligated to buy or sell.

The options contract has specific information such as the strike price and the expiration date. The strike price is the specific price that the asset is being bought or sold. The expiration date is the date on which the option expires. If the option is not exercised before that date, it becomes void and loses all value.

There are two types of options, puts and calls. A call is similar to a long position and gives the holder the right to buy an asset at a specific price. A put is similar to a short position and gives the holder the right to sell an asset at a specific price.

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