Share is Caring!

When you understand the basics of what an option is and how it works you will then be armed for working with them in the real world. An option is simply the legal right, but not the obligation, for a person to call (buy) or put (sell) the stock?s future or index at a specified strike (price) before a set amount of time has lapsed.

Options are inexpensive when you consider the costs of buying a stock outright. As an example if you purchase stock in XYZ Corp. You might spend $10000 to own it as it is $1000/share and the stock is typically traded in groups of 100; conversely, if you option the stock you may be able to get it for $800 because it may be listed at 8 points.

Options are for a block of 100 shares, so at 8 points, or $8/share, you are paying a fraction of the cost at $800 for 100 shares. Options are sold in blocks of 100.

With an option you do not own the stock; you are simply leasing the potential profits for a set amount of time. The time value of an option decreases the longer you own the option. You should know the difference between the call options and the put options.

Put options will give the buyer the rights to sell a specified number of the underlying instrument; this is usually 100 shares per contract and the price is called the strike price which is set with an expiration date.

Call options will give the buyers the rights to buy a certain number of the underlying instrument; this is typically 100 shares per contract and the specified price, the strike price, is set with an expiration date.

Find out more about options from Andrew Baxter, an expert investor and hedge fund manager. He has some great advice on investing in the Australian Share Market.