option


Definition
The right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike price) during a specified period of time. For stock options, the amount is usually 100 shares. Each option has a buyer, called the holder, and a seller, known as the writer. If the option contract is exercised, the writer is responsible for fulfilling the terms of the contract by delivering the shares to the appropriate party. In the case of a security that cannot be delivered such as an index, the contract is settled in cash. For the holder, the potential loss is limited to the price paid to acquire the option. When an option is not exercised, it expires. No shares change hands and the money spent to purchase the option is lost. For the buyer, the upside is unlimited. Options, like stocks, are therefore said to have an asymmetrical payoff pattern. For the writer, the potential loss is unlimited unless the contract is covered, meaning that the writer already owns the security underlying the option. Options are most frequently as either leverage or protection. As leverage, options allow the holder to control equity in a limited capacity for a fraction of what the shares would cost. The difference can be invested elsewhere until the option is exercised. As protection, options can guard against price fluctuations in the near term because they provide the right acquire the underlying stock at a fixed price for a limited time. risk is limited to the option premium (except when writing options for a security that is not already owned). However, the costs of trading options (including both commissions and the bid/ask spread) is higher on a percentage basis than trading the underlying stock. In addition, options are very complex and require a great deal of observation and maintenance. also called option contract.

Related Terms

derivative -  More

exercise -  More

covered option -

Related Terms on BusinessDictionary

binary option
Black Scholes option-pricing model
at-the-money option
out-of-the-money option
Margrabe option
Asian option
call processing
atlantic spread
in-the-money option
Barone Adesi & Whaley Model
diagonal spread
best of two option
rainbow option
AC-DC option
worst of two option
zero cost option
American option
butterfly spread
credit spread option
optioner
integrated planning
team roles
at-the-money forward option
option fund
intercommodity spread
theory of the second best
extension clause
deep in money option
externalities
real option
attributes data
deep out of money option
catastrophe equity put option
fair market value (FMV) lease
option seller
forward auction
intracommodity spread
traded option
fallback position
reverse auction
collar agreement
fax back
bargain purchase option
determinism
Committee on Uniform Security Identification Procedure (CUSIP) number
standing order
developmental license
London International Financial Futures & Options Exchange (LIFFE)
fixed purchase option
compound option
preemption right
Bermuda option
digital option
compressed workweek
underwater option
foreign exchange option
purchase option
scrip dividend
loss damage waiver (LDW)
concept search
variable rate demand obligation (VRDO)
purchase with purchase
best practicable means
doctrine of constructive receipt
variables data
Quanto option
bet option
double hedging
configuration management
freeware
FTSE 100
voidable
security
adjustable rate preferred (ARP) stock
due process
married put
derivative security
all or nothing option
electronic purse
costless collar
box option
equity warrant
modular bill of materials

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