Options are contracts under which the buyer obtains from the seller the right, but not the obligation, to buy (or call) or sell (put) a predetermined amount of stock shares at a preset price for a predetermined period of time. Options are derivative investment instruments, which means that they're derived (or, developed) from an underlying asset.

In the world of financial investments, stock options serve a variety of purposes. They can be used as a means of leverage (by controlling many more shares than could be bought for cash), for the protection of profits or the prevention of losses on other investments (also known as hedging), and for the production of income. Options can, however, be very speculative as well.

Trading options makes it possible for the investor to structure his or her portfolio in such a way that the level of risk exposure can be modified upward or downward while simultaneously increasing the opportunity to earn large profits. Many different approaches are available to accomplish this. Some allow for option profits to be taken during times when the market value of the underlying stock remains constant. Others are capable of generating sizeable gains on low-risk, minimal-capital investments. This, again, is the concept of leveraging and is the essential foundation of all options trading. In addition, the fact that an option costs less than its underlying security instrument provides the investor with yet another trade mechanism. Options trading, however, does involve significantly different risk and capital considerations than the more traditional forms of investment available in the stock market.

There are other advantages which can make trading in options quite attractive. For instance, it allows the investor to raise income from his or her stocks within a preset period of time. It can also provide protection for stock portfolios in the event of a downfall in the market. Additionally, options allow the investor to purchase stock at lower prices with limited risk. This is due to the fact that, as stated previously, the cost of options is much lower than the cost of the underlying stock. Finally, trading options allows the investor to gain wealth from an increase or decrease in the market value of a stock even though it's not personally owned by the investor.

Trading exchange option contracts became available to market investors in 1973 with the opening of the Chicago Board of Options Exchange (CBOE). The CBOE provided a marketplace where only option orders were placed and executed and thereby facilitating, for the first time, liquidity in the trading of options contracts. In simpler terms, options contracts could be readily bought and sold. This liquidity was ensured by the Options Clearing Corporation (OCC), which backs the standardization, issuance, and guaranty of options contracts.

Today, in addition to the CBOE, numerous other exchanges trade in options. These include such major entities as the American Stock Exchange (AMEX), the Philadelphia Stock Exchange, and the Pacific Stock Exchange, to name a few. All options exchanges are members of the OCC.

blog comments powered by Disqus
Scottrade