Lesson 1: Some Options Basics

This post is the first in a series that I will be starting on options basics.

Understanding how options work can be a daunting task. I can remember struggling to grasp the basic concepts and definitions of just the basics, and can relate to anyone just learning now. So, I'm going to attempt to outline and define some of the basic terms and concepts of options for you.

What is an option?

•   An option is a contract that allows the buyer the right to purchase or sell the underlying stock at a specific price within a specific time.

What is the difference between a call option and a put option?

•   A call option is a contract that allows the buyer the right (not the obligation) to purchase the underlying stock at a specific price within a specific time. 
•  A put option is a contract that allows the buyer the right (not the obligation) to sell the underlying stock at a specific price within a specific time.

What is the difference between buying and selling a call option?

• Buying a call option gives you the right (not the obligation) to purchase the underlying stock at a specific price within a specific time.
• Selling a call option gives you the obligation to sell the underlying stock at a specific price within a specific time.

What is the difference between buying and selling a put option?

• Buying a put option gives you the right (not the obligation) to sell the underlying stock at a specific price within a specific time.
• Selling a put option gives you the obligation to buy the underlying stock at a specific price within a specific time.
  

 Why should I trade options?

• Options provide the trader with a great deal of risk management techniques. Some of which enable the trader to hedge against potential losses, reduce the average cost of already purchased stock, and secure profits.
• Options also provide a way for traders to take advantage of higher priced stock movement due to the leverage. Since 1 option contract represents 100 shares of stock, retail traders with small accounts can participate in the higher priced stocks without ever owning them. 

That is all for now. I know that learning just this much the first time for me generated more questions than answers. So, feel free to ask any questions you have in the comments, and I will take the time to answer you. In the next lesson we will discuss some more terms and introduce the option chain. 


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