An option is a derivative financial instrument that represents a contract granting its holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (strike price) within a specified period or on a specific date.
Types of Options:
Call Option: Grants the holder the right to buy the underlying asset at the set price within a specified period. For example, if you hold a call option on a company’s stock, you can buy the stock at the strike price, even if the market price is higher.
Put Option: Grants the holder the right to sell the underlying asset at the set price within a specified period. For example, if you hold a put option on a stock, you can sell the stock at the strike price, even if the market price is lower.
Participants in Options Transactions:
Option Buyer: Purchases the right to buy (call) or sell (put) the underlying asset. The risk for the option buyer is limited to the cost of the option, known as the premium.
Option Seller: Obliged to fulfill the contract if the buyer decides to exercise their right. The seller receives the premium for the sold option, but their risk can be unlimited (in the case of uncovered option selling).
Types of Options:
European Option: Can only be exercised on the expiration date of the option.
American Option: Can be exercised at any time before the expiration date of the option.
Examples of Option Uses:
Hedging: Options are often used to hedge against risks. For example, a company might buy a put option on a currency to protect against a future decline in its value.
Speculation: Traders can buy and sell options to bet on changes in the price of the underlying asset.
Income Generation: Investors can sell options to earn premiums. For example, selling call options on stocks already held in a portfolio.
