An option gives the buyer the right to buy or sell the underlying at a specified price and time. At the same time, the seller has the obligation to take the opposite side and fulfill the option upon exercise. That means that the buyer can choose if they want to exercise the option, but the seller has to live up to the contract if the buyer does exercise.
A typical option:
Let’s analyze:
XYZ is the underlying instrument. This can range from equities (companies), indexes, futures, and currency. In this case we are using the company XYZ.
January is the expiration month and sets the life of the option. Expirations are always given in terms of a month. It is understood that options expire on the third Friday of every month. In this example, after the third Friday in January this option will no longer exist.
170 is our strike price. The strike price sets the price of the underlying if it were exercised. This is not the price you would pay to buy the option.
Call specifies if this is a call or put. A call is the right to buy or call the stock away from someone else. Too long a call you are making a bet the underlying will appreciate in price.
A put is the right to sell or put the stock to someone else. Too long a put you are predicting depreciation in price.
A put and call can be traded long and short or also in combination with other puts/calls to create spreads (more information on combinations to follow).
