Option definition

What is an Option in Finance?

An option is a financial instrument that gives its holder the right, but not the obligation, to buy or sell something at a predefined price within a designated date range. If the holder chooses not to exercise the instrument by the end of the designated date range, it expires. The two types of options are call options and put options, which are described below. In both cases, the option instrument contains an expiration date, which is the date by which the option must be exercised. After that, the rights associated with the option expire.

What is a Call Option in Finance?

The holder of a call option has a right to buy something from the other party to the option. This instrument becomes more valuable as the price of the asset to be purchased increases over time. The most common option arrangement is for a person to be awarded an option to buy the stock of his or her employer at a predetermined exercise price, which is usually the market price on the day when the option is awarded. If the market price of the employer's stock subsequently increases, the individual should exercise the option to buy shares, since he or she can then acquire the shares at the exercise price, rather than the current market price. If the market price instead stays flat or falls, the person cannot earn a profit and instead lets the option expire.

What is a Put Option in Finance?

The holder of a put option has a right to sell something to the other party to the option. This instrument becomes more valuable as the price of the asset to be sold decreases over time. Put options can be used to sell many types of assets, including stocks, bonds, commodities, and currencies. For example, Henry has a put option to sell his vintage roadster to Gregory for $100,000 within the next two years. The market price of the roadster drops to $90,000 during that time, so Henry exercises the option, forcing Gregory to pay the full $100,000 to acquire the car.