Option

An option is a contract between two parties that gives the buyer the right, but not the obligation, to buy or sell a specific asset at a set price by a certain date. The seller of the contract, often called the writer, takes on the obligation to fulfill that trade if the buyer chooses to use it. This is why options are called derivatives: their value is derived from the price of something else, like a stock, an index, or a commodity.

There are two basic types. A call option gives the buyer the right to buy the underlying asset at the agreed price, called the strike price. A put option gives the buyer the right to sell it at the strike price. Traders buy calls when they expect the price to rise and puts when they expect it to fall, though options are also used to hedge existing positions or to generate income by selling them to others.

Every option has an expiration date, after which it stops existing. Some options can only be exercised (used) on that exact date, called European-style, while others can be exercised any time before then, called American-style. The price paid for the contract itself is called the premium, and this is the maximum a buyer can lose, since they simply let the contract expire worthless if it's not worth using.

The nuance that trips people up is that owning an option is not the same as owning the underlying asset, and most options are never exercised at all. Traders typically buy and sell the contracts themselves, closing the position for a profit or loss before expiration, the same way they would trade a stock. The contract's price moves based on the underlying's price, time remaining until expiration, and expected volatility, not just on whether it is currently profitable to exercise.