Options are essentially derivative securities that are totally different from futures. While a future is an obligation on both the parties involved, options on the other hand, are simply an obligation on the seller’s part but the right of the buyer. The exact definition of options is an agreement to purchase a commodity on a future date at a price determined today mutually between the seller of the commodities and the buyer. The commodities can range from securities to tangible assets. In short, anything valuable is worth taking an option out on.
To understand the value of options and options trading, take the example of real estate. It is a very lucrative market that witnesses appreciation almost on a regular basis. Supposing a person is interested in purchasing a house at a price that he perceives as cheap today but lacks the complete amount required to acquire the property. If the seller agrees to take out an option on his property, then the buyer can simply pay a principal that shall validate the agreement and stop the seller from selling the house to anyone else for that duration. Once, the buyer has got the money arranged, he can come back to the buyer and purchase the house on the earlier decided amount. This ensures that the buyer pays the price that got him interested in the first place and not the appreciated price of present. In case, the property witnesses depreciation, then the buyer can decide not to exercise his right and forego the option thus saving himself a loss on property.
Some of the terms associated with options are put option, call option, strike value and expiration date. The right to buy is called as call option while the right to sell is called as the put option. The price that has already been determined beforehand is called the strike value, and the last date after which the option in void is called as the expiration date. When the option is being written, the issuer charges a certain price for making the option called as the premium.
Options are not bound between the buyer and seller. The buyer can resell the option to any other party and thus make a profit of the agreement itself. This is handled in two manners either through exchanges or through over the counter stock options. The first is very similar to stock exchanges while the other is calibrated for each buyer individually and then sold mostly by investment banks.
Just like other securities, one can make use of online options trading platforms that shall act as a broker for the investor. These platforms allow users to practice online, for free, without having to shelve out cash for actual options. Once the user is adept at online option trading strategies and acclimatized with the online option trading software, he can then try out using actual cash.
