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What Are Options?Although you may never have bought or sold stock options, you are probably familiar with the concept of options as it applies to other items. For instance, when buying a house you might have placed a nonrefundable deposit to hold a property for a short time while you looked at other properties. That is an example of a type of option. Similarly, you have probably heard about a Hollywood studio buying an option on a novel. In "optioning the novel," the studio bought the right to make the novel into a movie before a specified date. In both cases, with the house and the script, somebody put down some money for the right to buy a product at a specific price before a specific date. Buying a stock option is quite similar. When you purchase a stock option you purchase a contract that gives you the right, but not the obligation, to trade stock at a specific price before a specific date. Many individual investors find options useful tools because they can be used as either a type of leverage or a type of insurance. When used as leverage, options provide you with limited control over shares of a stock with substantially less capital than would be required to buy the shares outright. When used as insurance, options can partially insulate you from price fluctuations by granting you the right to buy or sell shares at a fixed price for a limited amount of time. Options are inherently risky investment vehicles and are not suitable for all investors. Options should only be traded by the most experienced and knowledgeable investors who are prepared to closely monitor market conditions and who are financially prepared to assume potentially substantial losses. Investors should read completely and understand the options disclosure document entitled “Characteristics and Risks of Standardized Options” (contact the Chicago Board Options Exchange at 800-OPTIONS to obtain a copy) before incorporating trading options into their investment strategy.
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