Option Definition
An option refers to a financial contract that provides an investor the right, but not the obligation, to buy or sell an asset at a specific price on or before a certain date. Options are derivative contracts used in both traditional and cryptocurrency markets.
Option Key Points
- Options are financial contracts that provide investors the right to buy or sell an asset, but not the obligation.
- Options are used in both traditional and cryptocurrency markets.
- An option contract specifies the type of option, the asset involved, the price per unit (or the strike price), and the date that the option expires.
What is an Option?
An option is a kind of derivative financial instrument. It is a contract that gives the investor the right, without the obligation, to buy or sell an asset at a specific price, on or before a particular date. The asset involved can be a stock, index, future, currency, commodity, or even a cryptocurrency like bitcoin.
Why are Options Used?
Options are primarily used for two main reasons: hedging and speculation. Investors use options to hedge against potential losses in the underlying asset. On the other hand, speculators use options to bet on the future price movements of the underlying asset, to profit from volatility, price directions, or both.
Who uses Options?
Options are typically used by traders, speculators, hedgers, and arbitrageurs. Retail investors can also use options, but these instruments usually require a certain level of trading knowledge and experience because of their complexity.
When are Options Used?
Options are used whenever investors wish to gain exposure to an asset, without actually owning it, or when they want to protect against potential price movements in the underlying asset. They can also be used to generate income through the selling of options, or for arbitrage purposes.
Where are Options Traded?
Options are traded in organized exchanges, over-the-counter markets, and recently, on decentralized exchanges within the blockchain and cryptocurrency spaces. Some of the famous global options exchanges include the Chicago Board Options Exchange (CBOE), and NASDAQ’s PHLX.
How do Options Work?
An option transaction involves a buyer and a seller. The buyer pays a premium to the seller in exchange for the right to buy or sell the underlying asset at a future date. If the buyer decides to use this right, the seller is obligated to fulfill the buyer’s decision. If the buyer decides not to exercise the option, the seller keeps the premium, and the option expires worthless. Each option contract usually represents 100 shares of the underlying stock in traditional markets, and a specified amount of cryptocurrency in crypto markets.
