An option is the right to buy or sell a certain financial instrument against a certain price within a certain period. For this right you need to pay a fee. Options are very risky and a bit more complex than stocks. However, by using options tactically you can increase your profits quite a bit.
How is an option formed?
An option consists of the following components:
The underlying value: the amount that the contract refers to. If you have the right to buy a stock against a price of 50 pounds through an option, then you know how much the underlying value is by multiplying the amount by the number of stocks.
Size of the contract: the number of contracts within the option. A contract always applies to 100 options; it isn’t possible to trade smaller amounts. When the price of an option is two pounds, you pay 200 pounds.
Type of option: an option can be a call or a put. The right to buy is a call option; you receive money when the price goes up. The right to sell is a put option; you receive money when the price goes down.
The execute price: the price at which you bought or sold a financial instrument. The execute price is usually not the same as the current exchange rate, which it can be lower and higher. The better the situation for the buyer of an option, the higher the fee becomes.
The expiration date: the moment an option is no longer valid. The fee you pay increases as the duration of an option increases because the party issuing the option must cover more risk.
Making money with options
There are two ways to make money from trading options. The first way is by buying an option. It’s also possible to write your own option. You then receive a fee and you can keep this fee as profit even if the option ends up being unfavourable.