In simple words, options contracts give buyers the right to buy or sell an equity at a pre-decided price and date. However, they are not obligated to do so. Well, what does that mean? Let’s break it down further. Imagine there is a stock currently trading at $100 per share. I can go ahead and purchase an options contract that allows me to buy that stock for $110 per share in a week from now. This is considered a ‘call option,’ an option that gives me the right (I’m not obligated to) purchase a stock in the future.
Now the question is, why would I want the right to buy a stock in the future? There are many reasons for doing so but the simple answer would be less initial investment than buying the stock outright. If I go down the typical route and decide to purchase the stock outright, I’d need to put down $100.
On the other hand, with an options contract, I only need to pay the premium and if my predictions are right, I pocket the difference in a week. For instance, if I buy the contract for $2 and in a week, the stock goes up to $115, I still own the right to buy it at $110. So I’d be able to execute my option and pocket the $5 difference ($115-$110). And, I only had to invest $2 to make the bet! I think we are all starting to see the bigger picture now.
Great guide! everyone makes options seem like a very risky game but your breakdown helps. Did you have any tips on how to find good contracts?