Stock options serve as a contract between two different parties, a buyer and a seller, giving the buyer the right to exercise the contract before or on a specific future date, called the exercise date or expiration date, allowing them to buy or sell an underlying stock at a price which is previously agreed upon.

 

Okay, let us explain this in a different way: If you buy a stock option for the shares of a specific company for $10 per share today, you are allowed to buy the shares of that company for the same price, $10, any time in the future as long as the contract has not expired. This means that no matter how much the company's shares cost in the future, if your contract has not expired, you can still buy shares for the original purchase price of $10. So even if that stock is trading at $100, if you own the right to buy it at $10, you can make a nice profit. Buying and selling stock options is much different than simply buying and selling the stocks' shares themselves. With stock options trading you are actually buying and selling the "right to buy" or the "right to sell" at a pre-determined price.

 

The rights that are conferred using a stock option are not rights which last forever, because there are fixed expiration dates on all stock option contracts. In the United States, stock options expire on the third Friday of each and every expiration month, which is known as the expiration date.

 

Because stock options are defined by their relationship to an underlying stock, these options are generally referred to as derivatives. These are fast becoming an asset class in the same way that futures and warrants are, because they are becoming well known for their potentials with hedging and leveraging.

 

Stock option contracts are based on underlying stocks. Other financial instruments with similar option contracts are Forex, ETFs, Commodity, Index and Real Estates in many cases. Every financial asset that is capable of being bought and sold is capable of having options written between all potential sellers and buyers.

 

There are two different types of stock options, called call options and put options. The put options give the right to sell the asset for a specified strike price to the holder. Call options on the other hand give the right to the holder to purchase the same asset for a specified price. When the holder of either of these forms of option contracts uses their right, it is known as exercising that option. In other words, for the holder of a call option to purchase stock at a specified price, they are exercising the option to buy that underlying asset.

 

There are also two different styles of stock options, known as American Style and European Style options. The American style Options can be exercised at any time that the holder wishes between the date of the purchase until the day of expiration. European style Options on the other hand can only be exercised on the day of expiration.