Tuesday, January 4, 2011

Option

An option is a kind of derivative that grants the holder the right but not the obligation to buy (call option) or sell (put option) a specified asset at a specified price (strike price), in a specified quantity, on or by a specified date. The usual quantity for a stock option is 100, thus an option with a $1 premium will cost $100 to buy. When an investor wants to buy an option, they must pay a premium in order to gain the option (i.e. the right, but not the obligation to transact). Thus options can be understood like insurance. Indeed one form of portfolio insurance is when an investor buys put options (the option to sell - which will profit if the stock price goes down). As an example the investor might think that markets will go down, but does not want to sell their portfolio, so instead they buy some index put options, later the index falls and the option premium increases, so the investor records a profit (the difference between the current option premium price, and the premium that the investor initially paid).

Synonyms: Call option, Put option, LEAPs, Stock option

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