An Option Contract

An option contract is a contract to buy or sell a specific financial product officially known as the option's underlying instrument. The underlying instrument can be a stock, exchange-traded fund (ETF), or similar product. It also can be commodity products such as grain, rice, sugar and oil. It establishes a specific price, called the strike price, at which the contract may be exercised, or acted one. And it has an expiration date. When at option expires, it no longer has value and no longer exist. The holder of the option can choose to have either American option or European option. The difference is that for American option, the option can be exercised at any time before the expiration date. In contrast, European option only can be exercised at the expiration date. In general, American option is more expensive than European option..

Options have two types, calls and puts, and each option contract has a buyer, called as the holder, and a seller, known as the writer. If you are the holder of a call option, you have the right but not obligation to buy the asset at the strike price before the expiration date. The holder of a call option gains when the price of the underlying instruments increases compare to strike price. As example, given a strike price of $80, the holder obtains a positive payoff when the price of the asset increases to $90. This means that the holder can exercise the call option to buy the asset at the price of $80 instead of $90. In contrast, when the price of the asset decreases to $70, the holder is not obligated to exercise the call option. Instead of buying the asset at the strike price of $80, the holder can choose not to exercise the option and buy the asset at the current market price at $70. The second type of option is put option, which gives a right but not obligation for the buyer to sell the asset at the strike price before the expiration date. In contrast with call option, the holder of a put option gains when the price of the asset decreases. If the asset price increases, the buyer will not exercise the put option because it is more profitable to buy the asset at current market price. Both of these options protect the buyer of changes in price and generally this is useful method for investor to hedge in stock market.

The other side of long position is short position also known as the writer of the option. The writer is obligated to fulfil the position when the holder wishes to exercise it. As the holder of option contract acted as a holder of insurance policy, you as a writer of option contract acted as an insurance company on someone else's asset. The writer has no control over the option control, and in fact, the writer has unlimited