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Market Basics Learn About Options The Basics What is an Option?

What is an Option?

May 15, 2020

An option is a type of security that grants the trader the right to buy or sell an underlying asset. The underlying instrument is commonly a stock, but options can also be traded on a variety of ETFs and futures. There are two types of options: call options and put options. Traders can trade options by either selling, buying or a combination of both.

A call or put option is a contract between two unknown parties, a buyer and a seller. The option buyer and option seller will have different rights and obligations if they hold their options until the date it expires. Depending on whether you have bought or sold the option, you may be able to decide whether you want to own the stock (when you buy the option) or you can be assigned stock (when you sell options). There may also be actions that need to be taken depending on whether the option you traded has value by the date it expires.

Buying to Enter a Trade Selling to Enter a Trade
Calls This Trader has the right but not the obligation to Buy This Trader has the obligation to deliver long shares if assigned
Puts This Trader has the right but not the obligation to Sell Short This Trader has the obligation to deliver short shares if assigned

Options are traded in contracts, and generally each option contract represents 100 shares of stock. The price or premium of an option contract is determined by a number of pricing factors that include:

  1. The underlying stock price
  2. The contract strike price at which you can buy or sell the stock
  3. The expiration date of the contract
  4. Volatility
  5. Stock dividends and interest rates to a lesser degree when applicable. Economic or other related news events can also have a significant effect on options prices.

The price quoted for a stock option is the per-share price of the option. So, if an option is quoted at $5.00, the cost to buy that option would be $500.00 ($5 X 100 shares). Remember, one option contract generally represents 100 shares of stock.

Although stock options have an expiration date, most option contracts allow the trader to go into the open market and close their options position(s) prior to the expiration date, to either take profits or limit losses.

Learning which stock options to buy or sell and when to buy or sell can feel overwhelming at times, especially with all of the terminology specific to options trading. While it may require traders to understand the language of options trading, it can be a rewarding way to trade.

Although stock options have an expiration date, most option contracts allow the trader to go into the open market and close their options position prior to the expiration date, to either take profits or limit losses.

Learning which stock options to buy or sell and when to buy or sell, when to hold your position and when to close your position requires knowledge and experience you can gain through education and coaching.

Discover the advantages of trading Options with TradeStation

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See also

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Why Trade Options?

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What You Need to Know About Trading Options

Market BasicsOptionsTrading options will require a trader to commit to understanding the terms used when trading options, as well as to consider some additional tools to trade. Options trades are traded on an options chain. There are a lot of options...

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