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• Stephen Cooper

Explanation of stock options

What are stock options? We explain stock options

Stock options can be a very tricky subject for beginning investors. Options are a somewhat esoteric financial instrument, which offer certain characteristics that are similar to stocks, but with enough variance to require study.

An investor who buys an options contract has the right to purchase 100 shares of stock at a later date. This can be a big advantage to an investor in a rising market. Writing an options contract to purchase stocks later is called selling put options.

If the investor is confident that a stock will go down, he can sell 100 shares of the stock and then buy them back later at a lower price.

Many times investors will buy options contracts to hedge their current trade. If they aren't completely sure, they can take some downside risk away, by betting an amount of money on the opposite trade.

The most common use of options contracts is to hedge trades of the underlying stocks. If someone is long a stock, they will buy puts to ensure some sort of profit just in case the stock goes down. Investors can use the fact of the small premium of options contract to control a much larger block of underlying stock. Options, unlike stocks, can and will expire worthless on certain dates, so timing is more important that with other types of trades.