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An option is a type of derivative - its value is derived from an underlying asset, such as a stock. The party that buys the option is called the option holder; the party that sells the option is called the option writer. An investor can be either a holder or a writer.

Options come in two types: calls and puts.

A call option gives its holder the right, but not the obligation, to buy a certain security at an agreed-upon price (the strike price) for a specified period of time (the term). The strike price and the term are determined when the option is purchased.

A put option gives its holder the right to sell a security at the strike price for a certain term. Just as with call options, the strike price and term for a put option are determined when the option is purchased.

Additional Comments:

Sometimes options are used as risk-management tools.

For example, if an investor is overly concentrated in a certain stock that she can’t easily sell for some time (maybe it’s her company’s stock and she’s prohibited from trading it for a time, given her position with the company), then she can buy a put to protect her downside risk.

Related Terms:

Refers to the option writer's (seller's) obligation to sell or buy a stock or other financial ...

Covered Call
A strategy that involves buying stock shares and selling calls. If the calls are assigned, the ...

Option Premium
The price of an option; the amount of money that the option holder pays for the ...

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