What Are Options Contracts

Options contracts provide you with the right, but not the obligation to buy or sell an asset, like a stock, for a price. Prior to an asset's maturity date or a pre-determined date you cannot buy or sell the asset.

In general one hundred shares of an underlying stock represents one options contract. Options contracts have two parties. The buyer called holder and the seller called writer. To exercise an options contract, the writer must fulfill the formalities in the contract by giving shares to a suitable party. In some cases where cash is used to settle an options contract the index security cannot be delivered. The option expires if not exercised, but the holder's losses are held to the money he put up to take up the option. Should the option expire no one can do any trading of the shares. The buyer benefits from this deal, but the writer suffers considerable loses unless the contract is covered.

The options contract has an asymmetrical payoff pattern similar to that of stocks. Commonly options contracts are used for leverage or protection. When used as leverage, the option gives the holder control over the equity in a smaller amount. Control is a mere fraction of the actual value of the shares. The difference of the amount saved can be wisely invested into more profitable ventures until the option is exercised, or sold.

The use of options provide good protection from the forceful price fluctuations in the market. They give you the right to hold the underlying stock at a pre-determined price for a specific duration. When the writing options for a security are not owned, the risk is minimized to the option premium. Not withstanding, the trading option's price is high if dealing on a percentage basis instead of trading the underlying stock.