Options Contract - Explained
What is an Option Contract?
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Table of ContentsWhat is an Options Contract?How Does an Options Contract Work?Call Option ContractsPut Options
What is an Options Contract?
An options contract refers to an between a buyer and a seller of securities in which both parties reach a consensus to buy or sell the underlying security at a later date at an agreed price. The price at which the underlying security is to be purchased in the future is a prest price and this price and other terms of the contract cannot be revoked by any of the parties. There are two types of options contract; the put options and the call options. Generally, options contracts are used in transactions involving the trade of assets, securities, and commodities and for real estate transactions.
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How Does an Options Contract Work?
The parties involved in an options contract, be it the seller or buyer enter the agreement with the expectation that the future market will be to their benefit. For instance, call options are mostly entered with the anticipation for an increase in the price of the underlying stock while put options are entered by individuals who believe that prices of the underlying securities will reduce and to their advantage. This is why in an options contract, a trike price is agreed upon by both parties, prior to the expiration date of the contract. In a put option, a buyer can sell their shares at the agreed strike price while the other party fulfills their part in the contract. This is also applicable in a call option.
Call Option Contracts
Call options contracts give the buyer of the option the right and not an obligation to buy the underlying security (asset, stock or bond) at the preset price or agreed strike price as the expiration date of the contract. When individuals or investors purchase a call option form a write or option seller, the seller received a premium as takes on the responsibility of selling the underlying asset at the strike price agreed in the contract. The expiration date is also stated in the terms of the contract.
In a put option contract, buyers of such contract take that position with the speculation that the price of the underlying securities will decline before or at the expiration date of the contract, translating to higher gains. Owners of put options can sell the underlying security at an agreed price at the expiration date (future time). Here are the key takeaways of options contracts;
- An options contract is an agreement between two parties; a buyer and a seller to transact underlying security at a preset price in the future. That is, the security will be traded on its expiration date at a price agreed much earlier.
- There are two types of options contracts, these call options, and put options.
- Options contracts are used in the real estate and for the transaction of securities, assets, stocks, and bonds.
- When used in stock trading, a single stock options contract covers 100 shares of the underlying stock.