An option is a contract that gives the owner the right, but not the obligation, to buy or sell a security

at a particular price on or before a certain date.

Investors buy and sell options just like stocks. There are two basic types of options:

The call option The put option

The Call Option The call option is the right to buy the underlying security at a certain price on or before a certain date.

You would buy a call option if you anticipated the price of the underlying security was going to rise before the option reached expiration. For example:

Company XYZ in trading at $25 per share and you believe the stock is headed up. You could buy shares of the stock or you could buy a call option. Say a call option that gives you the right, but not the obligation, to buy 100 shares of XYZ anytime in the next 90 days for $26 per share could be purchased for $100.

If you are right and the stock rises to $30 per share before option expires, you could exercise your option and buy 100 shares at $26 per share and sell them for an immediate profit of $3 per share ($30 - $26 = $4 - $1 for the option = $3 per share profit).

You could also simply trade the option for a profit without actually buying the shares of stock.

If you had figured wrong and the stock went nowhere or fell from the original $26 per share to $24 per share, you would simply let the option expire and suffer only a $100 loss (the cost of the option).

The Put Option The put option is the right to sell the underlying security at a certain price on or before a certain date.

You would buy a put option if you felt the price of a stock was going down before the option reached expiration.

Continuing with out XYZ example, if you felt the stock was about to tank from $25 per share, the only way to profit would be to short the stock, which can be a risky move if youre wrong. See Short Selling - Not for the Faint Hearted.

You could purchase a put option at $24 per share for $100 (or $1 per share), which would give you the right to sell 100 shares of XYZ at $24 per share.

If the stock drops to $19 per share, you could, in theory buy 100 shares on the open market for $19 per share, then exercise you put option giving you the right to sell the stock at $24 per share making a $5 per share profit, minus the option cost.

As a practical matter, you would trade your put option, which would now be worth something close to $5 per share or $500.

Basic Option Facts Here are some quick facts about options:

Options are quoted in per share prices, but only sold in 100 share lots. For example, a call option might be quoted at $2, but you would pay $200 because options are always sold in 100-share lots. The Strike Price (or Exercise Price) is price the underlying security can be bought or sold for as detailed in the option contract. You identify options by the month they expire, whether they are a put or call option, and the strike price. For example, an XYZ April25 Call would be a call option on XYZ stock with a strike price of 25 that expires in April. The Expiration Date is the month in which the option expires. All options expire on the third Friday of the month unless that Friday is a holiday, then the options expire on Thursday.

Conclusion This quick overview of options gives you an idea of what they are all about, but it is the very tip of the proverbial iceberg. Options are not for the beginning investor, but do offer advanced traders another tool for their investment arsenal. ---------------------Options Contract is a type of Derivatives Contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. The buyer / holder of the option purchases the right from the seller/writer for a consideration which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc. Under Securities Contracts (Regulations) Act,1956 options on securities has been defined as "option in securities" meaning a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities. An Option to buy is called Call option and option to sell is called Put option. Further, if an option that is exercisable on or before the expiry date is called American option and one that is exercisable only on expiry date, is called European option. The price at which the option is to be exercised is called Strike price or Exercise price. Therefore, in the case of American options the buyer has the right to exercise the option at anytime on or before the expiry date. This request for exercise is submitted to the Exchange, which randomly assigns the exercise request to the sellers of the options, who are obligated to settle the terms of the contract within a specified time frame. As in the case of futures contracts, option contracts can be also be settled by delivery of the underlying asset or cash. However, unlike futures cash settlement in option contract entails paying/receiving the difference between the strike price/exercise price and the price of the underlying asset either at the time of expiry of the contract or at the time of exercise / assignment of the option contract.

Types of derivatives
Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today's pre-agreed price. Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. Options: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are:

Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.

Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.

Warrants: Options generally have lives of upto one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter. LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of upto three years. Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options. Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating.