In the stockmarket, an option is a contract that gives its purchaser the prerogative to buy or sell shares up to a stipulated date. You should note here the buyer gets the right, but isn’t required to purchase or sell stock.
Let’s explain this with an example: Let’s make the assumption the stock of IBM is trading at $25 today, and you predict it to go up. That means you are bullish on IBM, and thus you’ll buy its “buy option” up to a later specified date (say a month) at say $27 by paying a tiny premium. Now assume that stockholders take up IBM’s price to $40 in the month of May. At this point you can decide to book profits by selling your option contract. On the other hand, if IBM’s share price remains static or turns negative, then you can select not to exercise your option and your maximum loss will be the premium you paid for purchasing the option.
When you are learning the trading lingo begin by knowing there are 2 sorts of options and they’re referred to as “Calls and Puts.” A Call option gives its owner the inherent right to buy a share at a stated price within a stated period. Buyers of call options are bullish on the stock – they feel the share price will rise before the date the option contract ends. A put option gives its owner the inherent right to sell a share at a cited price within a specified period. Buyers of put options are bearish on the stock – they expect the share price to drop before the date cited in the contract.
The very next thing you need to understand are the players that make up the option market. You have got the purchasers of the call options and the purchasers of the put options. Then you have the sellers of the call options and the sellers of the put options. Then you have got the people who buy option contracts and they’re called as “holders”, while people who sell them are called “writers”.
In option trading there’s a very important difference between owners and sellers of options – It is not compulsory for a customer of a choice contract to sell or purchase, it is compulsory for the vendor of an option contract to make good his side of the contract.
When you’re ready to start you really should know some of the typically used lingo. For instance the phrase “Strike Price” means the price at which a share option can be acquired or sold. Then you have the “expiration date” which is the last date of the option contract’s validity – after this date it ceases to exist.
Another term to know is “in-the-money,” a call option contract may be said to be in-the-money when the stock price goes higher than the strike price, while a Put option is in-the-money when a share’s price goes below the strike price. Finally there is the “premium” which is the price of an option.