Options The Basics

exercising the option

The act of buying or selling the underlying asset via the option contract.

strike price

The fixed price in the option contract at which the holder can buy or sell the underlying asset. Also, the exercise price or striking price.

expiration date

The last day on which an option may be exercised.

American option

An option that may be exercised at any time until its expiration date.

European option

An option that may only be exercised on the expiration date.

An option is a contract that gives its owner the right to buy or sell some asset at a fixed price on or before a given date. For example, an option on a building might give the holder of the option the right to buy the building for $1 million anytime on or before the Saturday prior to the third Wednesday of January 2010.

Options are a unique type of financial contract because they give the buyer the right, but not the obligation, to do something. The buyer uses the option only if it is profitable to do so; otherwise, the option can be thrown away.

There is a special vocabulary associated with options. Here are some important definitions:

1. Exercising the option. The act of buying or selling the underlying asset via the option contract is called exercising the option.

2. Strike price, or exercise price. The fixed price specified in the option contract at which the holder can buy or sell the underlying asset is called the strike price or exercise price. The strike price is often called the striking price.

3. Expiration date. An option usually has a limited life. The option is said to expire at the end of its life. The last day on which the option may be exercised is called the expiration date.

4. American and European options. An American option may be exercised anytime up to and including the expiration date. A European option may be exercised only on the expiration date.

call option

The right to buy an asset at a fixed price during a particular period of time.

put option

The right to sell an asset at a fixed price during a particular period of time. The opposite of a call option.

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