- What Is a Stock?
- What Is an Option?
- The Bet You Wouldn't Make
- The Options Trader's Toolbox
This chapter is from the book
This chapter is from the book
This chapter is from the book
What Is an Option?
An option is a contract in which one party sells risk for a price. Gambling is the same thing. You go to the tracks and place a bet on a horse. The track takes the risk and sells you the bet and promises to pay if you win. If you take and sell that bet to someone else, you are selling that promise. An option is a legally binding promise that can be bought and sold. The person selling the risk writes the promise, which is why selling an options contract is frequently called “writing.” An options contract allows the buyer to exercise the terms of the promise at any time before the option expires.
Contract law is defined by three elements: offer, agreement, and consideration. An option is a contract between two parties. Exchanging money for the risk implied in the promise is the consideration. All contractual agreements are about promises.
Explaining options is notoriously difficult. Expressed basically, you buy calls when you expect the price of the underlying security to go up, and you buy puts when you expect the price to go down. But options are more complicated than this. You also have to consider what happens before, during, and at the end of a trade.
To flesh out and get a better understanding of options, it might actually be better to think of options as a bet. I personally shiver at the idea of what I do as gambling but, upon reflection, it shares more with gambling than stocks do, but in a good way.