What Are Options?
Options are versatile financial instruments that derive their value from an underlying security, such as stocks, indexes, and exchange-traded funds (ETFs). Unlike futures contracts, options offer buyers the right—but not the obligation—to buy or sell the underlying asset at a predetermined strike price within a specific time frame.
Key Takeaways
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Options provide the right, but not the obligation, to buy or sell an underlying asset at a set strike price.
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Two main types:
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Call options — benefit from an increase in the asset’s price.
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Put options — profit from a decline in the asset’s price.
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American vs. European Options: American can be exercised anytime before expiration, while European only at expiration.
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The Greeks: Key risk metrics —
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Delta: price sensitivity
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Theta: time decay
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Gamma: rate of delta change
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Vega: volatility sensitivity
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Options strategies (like spreads) combine buying and selling to manage risk and capture opportunities in volatility and price movements.
How Options Work
Options contracts involve a buyer and a seller. The buyer pays a premium for the rights granted by the contract:
Call Options: Allow the holder to buy the asset at a stated price within a specific time frame.
Put Options: Allow the holder to sell the asset at a stated price within a specific time frame.
Each call option has a bullish buyer and a bearish seller, while put options have a bearish buyer and a bullish seller.
Why Traders Use Options
Leverage: An option with no intrinsic value that would result in a loss if exercised immediately.
Hedging: Reduce or manage risks in a portfolio.
Speculation: Profit from expected price movements with defined risk.
Note: Options trading involves significant risk and may not be suitable for all investors.
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