What are Options?

Today we are going to talk about Options and its different types, like call options and put options. Previously we talked about  Operations of Private Equity Firms, Negative Equity and Return on Equity.

Options are derivatives of equity securities. While it is also an equity security in itself and traded on the stock exchange, it cannot function on its own where shares of the company have not been authorized. Just as warrants, options are basically contractual rights that are given to individuals, potential investors, and even staff of the company for the trade of a company’s shares at a predetermined price before a stipulated expiry date. Note that only rights are given and not the obligation to do so.

From the foregoing, it is easy to see the relationship between warrants and options. While both have their many differences, the core difference is that warrants are offered by companies themselves and sometimes over the counter, while options are traded on the stock market. It is not uncommon to assume that an option only allows you buy at a set price sometime in future. However, options can either be bought or sold since it is traded on the stock exchange.

There are certain terminologies used with options that should be understood in order to understand the concept of its trade. They include:

Basically, call options represent the right you are given to buy the shares of an entity on the relevant stock exchange. The price is set, and the date is set as well. Since it is traded publicly on the secondary market, it is usually very transparent and based on a clear contract. The catch with the call option is that the buyer can to buy it at a lower price and peradventure the stock price increases, he or she would make a profit. In essence, you make profits when the exercise price is lower than the general market value.

  • Put Options

As the opposite of call, put simply means that you have a right to sell a predetermined number of shares at a set time and price on the secondary market. As in call option above, where the individual believes that the stock would reduce in value, he or she decides to enter a put option to be sold some other time in the future. Since the set price is fixed, when the price of the option goes even lower, the option holder can sell it at a premium. What this means is that profit is made when the exercise price is higher than the general market value.

An option is usually used to retain employees, attract investors, and so much more. Some of the general characteristics of it include:

  • Strike price

The strike price is also known as the exercise price. It is the set price for the option to be bought or sold at.

  • Expiration date

Just like warrants, an option has a clear expiry date. It is the date after which the option contract would become irrelevant; it is usually shown on the option contract as well.

 

  • Number of expected shares

Finally, the number of shares of an option has to be predetermined and shown on the employee or investor’s contract.

These are the key features of an option instrument.

In the next story, we will be talking about Bitcoins and Risks associated with it.

Related: WHAT ARE STOCK WARRANTS?

What are Stock Warrants
What are Stock Warrants

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