Option

From Reuters Financial Glossary

An option gives the buyer or holder the right, but not the obligation, to buy or sell an underlying financial asset or commodity. Unlike futures, where the buyer has to fulfil the contract, an option gives the choice of whether to exercise or not. An option contract specifies a future date on or before which it can be exercised. This date is known as the expiry date. The price of an option ⿿ the 'strike' or 'exercise' price ⿿ is the price at which it can be exercised. Options are very flexible instruments. They allow investors to benefit from favourable price movements while limiting the consequence of unfavourable price movements. Options holders have to pay a 'premium' for this protection as with any insurance contract. There are two kinds of option. A call, which gives the holder the right to buy the underlying instrument at a set exercise price, and a put, which gives the holder the right to sell the underlying instrument at a set strike price. More than one option transaction can be combined to create a spread. These strategies usually involve the simultaneous purchase and sale of options with different prices, or expiry dates, within the same class. American style options can be exercised at any time before the expiry date, whereas European style options can be exercised only at the specific expiry date and not before. Options can be traded on a recognized exchange such as the Chicago Board of Trade or over the counter (OTC).

See also: Derivatives, Futures, OTC, Spread, Greeks