What is Options Contract?
749 reads · Last updated: December 5, 2024
An options contract is an agreement between two parties to facilitate a potential transaction on an underlying security at a preset price, referred to as the strike price, prior to or on the expiration date.
Definition
An option contract is a tool that allows parties to agree on a potential transaction at a predetermined price (strike price) before or on the expiration date. It grants the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price within a certain timeframe.
Origin
The concept of options can be traced back to ancient Greece, but the modern options market began with the establishment of the Chicago Board Options Exchange (CBOE) in 1973. This marked the start of standardized option contracts, making options trading more widespread and regulated.
Categories and Features
Option contracts are primarily divided into call options and put options. A call option gives the holder the right to purchase the underlying asset at a specific price on a future date, while a put option gives the holder the right to sell the underlying asset at a specific price on a future date. Key features of options include leverage, limited risk, and flexibility.
Case Studies
A typical case involves trading options on Apple Inc. Investors might buy call options on Apple, hoping to profit from a future increase in stock price. Another example is put options on Tesla Inc., where investors might purchase these options to hedge against a potential decline in stock price.
Common Issues
Common issues investors face when using option contracts include misunderstandings of option pricing models, such as the Black-Scholes model, and improper selection of expiration dates and strike prices. Investors should understand the time value and intrinsic value of options to avoid unnecessary losses.
