What are Options?

ptions are financial derivatives, meaning their value is derived from the price of an underlying asset, which could be a stock, bond, commodity, currency, or even an index. Options give the holder the right, but not the obligation, to buy or sell the underlying asset at a predetermined price, known as the strike price, before or at a certain date, referred to as the expiration date.

There are two main types of options:

• Call Options: These give the holder (buyer) the right, but not the obligation, to buy an asset at a specified price within a specific time period. Traders buy call options when they believe the price of the underlying asset will increase.

• Put Options: These give the holder the right, but not the obligation, to sell an asset at a specified price within a specific time period. Traders buy put options when they believe the price of the underlying asset will decrease.

It's important to note that for every options contract, there's a buyer and a seller (also known as the writer). The buyer pays a premium to the seller to enter into this contract. If the option is exercised, the seller is obligated to fulfill the terms of the contract by either selling or buying the underlying asset at the strike price.

Options can be used for various purposes, such as hedging risk, generating income, or speculating on price movements. Understanding how options work and how to use them effectively can be a powerful addition to your trading strategy.

In the next chapter, we'll delve deeper into the mechanics of options, so you can better understand how they operate and how they can be used in different market scenarios.