2. What Are Stock Options?

How Do Options Work?

All options transactions involve two parties: a buyer and a seller (often referred to as the option writer).

The buyer is purchasing the right (but again, not the obligation) to buy a certain stock at a later date if a certain price is reached.

All option contracts have expiration dates, with some reaching out as far as multiple years. However, options can’t be held forever and the longer the time frame, the more expensive the contract will be.

If the buyer thinks a stock is currently undervalued, they might purchase a ‘call’ option in order to buy the shares cheaply after a large melt up. The buyer pays the option writer for the contract, which is known as the premium.

If you purchase an option and the underlying stock doesn’t reach the predetermined price (called the Strike Price), the contract will expire worthless.

If the stock does reach the strike price, the option will be ‘in the money’ (ITM) and the buyer will have the ability to purchase shares of the stock at the strike price, even if the shares have soared 60% above that price. 

One contract gives the buyer the option for 100 shares, but the buyer doesn’t need to exercise the contract when the strike price is hit.

Options can be bought and sold on exchanges just like the underlying stocks themselves. 

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