Stock Options

In the world of high finance many terms are used that the vast majority of people, most likely, have no knowledge of. As we plan for retirement or just try to do a little investing we may be presented with some of these terms and have a little trouble understanding what they mean or how they can earn us money. In this article I will give you a little background on stock options. Most of us know that a stock is a security which signifies an ownership share in a company. When we buy it we know that we know own, or have equity in, that company, and that the value of the stock we own is determined by the value of the company, or at least the value that people believe the company is worth. Now in the context of stocks we will hear about call and put options, but what are they?

Options, put most simply, are just that, the option to do something. When we get an option we now own the right to exercise our option by a specified date. In a regular world example (non finance) its almost like buying a coupon from someone. Let's say I buy a coupon from someone for a dollar which is for a theme park ticket to be purchased for twenty dollars. If the price of the theme park goes on sale for less than twenty before my coupon expires I probably wouldn't want to use it, but If the price of the ticket remains above twenty one dollars before the expiration date of my coupon then I have made a good deal. (I say $21 because e paid a dollar for the option of using the coupon).

Now how does this translate into the stock market? Well the above example would be a call option. A call option is the right to buy an asset at a set price before a specified date. So if the price of the asset goes up from the amount of your option you are in the money and should exercise (use) it. If the price of the asset falls below that price, plus the amount you paid for it, it would be silly to use it since you would be losing money.

Put options are true in reverse. A put option is the right to sell a stock at a specified price for a set duration. If the price of the asset falls below the price you are able to sell it at then it's a good idea to sell, because you would be making more than you otherwise would by selling without the option.

Options are a little tricky because you have to buy them, and if they go unused you don't get the money back. So you need to look at that money as a sunk cost when planning any option purchases.