An option in finance is explained in full under options contract, which covers pricing, exercise and the main strategies. This page gives a short definition of the single word, which traders use far more often in practice.
An option is a derivative contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a fixed price, called the strike price, on or before a specified expiry date. The buyer pays the seller an upfront premium for that right. There are two basic kinds:
- Calls. A call option gives the right to buy, and gains value as the underlying price rises above the strike.
- Puts. A put option gives the right to sell, and gains value as the price falls below the strike.
Options exist on shares, indices, currencies, commodities and cryptocurrencies such as bitcoin and ether, and are traded both on exchanges and over the counter. The buyer's loss is limited to the premium, while a seller can face large losses. The word "option" is also used in everyday finance for employee share options, which follow the same logic but are granted rather than traded. Where and how options trade is described under options market.