What Are Options?

Options are contracts that bestow the right to buy or sell a security at a set price on or before a set date. Essentially, options allow you to lock in prices on a wide range of financial instruments, including stocks, stock indices, currencies, and even futures, all of which are known as underlying securities. The options contract specifies a set market price, or strike price, at which you may buy or sell the security, and an expiration date upon which the contract becomes void.

There are two basic types of options. A put contract gives its holder the right to sell the underlying security, while a call contract confers the right to buy. You can choose either to exercise your option, or you may allow it to expire without actually buying or selling the security. The majority of options contracts, however, are sold on the secondary market before the expiration date.

The market value of the contract at any given time will depend on the current market price of the underlying security. For example, if the strike price on a put contract for a stock is higher than the stock's current market price, the option has intrinsic value and is said to be in the money. If the strike price were below current market value, the option would have no value (today, at least) and would bring a lower price.

Options allow traders to capitalize on changes in market prices. The options market is highly volatile, as small changes in securities prices can have a significant effect on the price of options contracts derived from them.

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