Reviewing Options - Investment or Speculation?
Many people new to options may feel little uncomfortable. In some circles of non-professional investors the word “options” conveys the notions of high risk and speculation. Of course, its true that options can be used to speculate, the same can be said for other investment stuff, for example day trading is the common example of speculation with stocks. Options can be used in a variety of ways from investment oriented to speculative. Options have potential to add value to what you are already doing whether conservative or aggressive, income-oriented or capital gains-oriented.
The purpose of this article is to discuss what options are, how they work and when they might be used to enhance investment activities.
Going forward one other important factor to discuss here is that, options have the date of expiry, so the investing or trading with options is different from investing or trading with stocks. That’s why the options users must be aware, active and well planned in advance than the stock traders or investors
Let’s begin familiarizing with some common terms.
Option is a contract between a buyer and a seller (or writer). Both buyer and seller/writer/owner has a right, but not an obligation, to buy or to sell some underlying instrument* at a specified price until an expiration date.
*Underlying instrument can be a stock, a commodity, a futures contract, a foreign currency or a stock index. In this article we use this term specifically for stocks only.
The option buyer and seller, have the right, but not obligation, to buy and sell some underlying instrument/stock respectively at a specified price until an expiration date. The option writer, or seller, assumes the obligation contained in the option contract and must fulfill the terms if the option buyer exercises the right.
Strike price is the price specified in the option contract at which the underlying instrument is bought or sold. The pre determined price to buy or sell, if the option is exercised on the mentioned due date.
Expiration date is the date after which the option contract ceases to exist. If an option is not exercised prior to the expiration date, the right contained in the option ceases to exist.
Now review the option definition again
An option is a contract that gives the owner/buyer the right, but not the obligation, to buy or sell a particular asset (the underlying stock) at a fixed price (the strike price) for a specific period of time (until expiration). The contract also obligates the writer/seller to meet the terms of delivery if the owner exercises the contract right.
More in next article
