Stock options are a type of financial derivative instrument. Put simply, they are the right to buy or sell a set number of shares at a time or price specified. A right to buy a stock is a “call” and the right to sell a stock is a “put.” Stock options give traders more flexibility and control over investing in the share market and are also used as remuneration tools for employees in a business. There are four different kinds of stock options: Exchange Traded Stock Options, Over-The-Counter (OTC) Options, Exotic Options, and Employee Stock Options.
Stock options are defined by a few traits, but the key characteristic of any option is the exercise, or strike price. This is the price at which the underlying stock can be bought or sold should the option-holder decide to exercise their right to buy or sell. There are two different types of options on the market: American stock options are exercisable at any time before the expiration date, whereas European stock options can only be exercised on the expiration date. Regardless of which kind of stock option a trader holds, this financial derivative instrument is a flexible way of investing.
Leverage your money
Stock options allow investors to leverage their money as they cost only a small fraction of the price of the underlying stock, but represent the same amount of shares. Options allow you to control the same amount of shares, with a lesser amount of cash, thereby producing leverage. This is termed Stock Option gearing.
Hedge against volatility
Stock options operate essentially like insurance policies. For example, a call option protects buyers from spiking prices, while a put option protects sellers from crashes in the share price. Options allows traders to hedge against risk without incurring margin implications.
Profit from both bear and bull markets
Investing in the share market usually means losses should share prices fall. However with stock options, investors can profit in both bear and bull markets. In the money call options allow you to buy rising stocks at a lower price than current market value; in the money put options mean that you can profit from falling share prices.
These are only a few of the basic functions of a stock option; they are variously used to increase employee motivation, improve buy-in of a company or to monitor a share’s rise and fall. Stock options are a flexible and useful financial derivative instrument.
References:
http://www.optiontradingpedia.com/stock_options.htm#call%20and%20put%20stock%20options
http://www.learn-stock-options-trading.com/online-options-trading.html
http://www.wisegeek.com/what-are-stock-options.htmons.html