A stock options contract gives the holder the right to buy or sell shares of stocks at a particular price in the future. Investors buy such contracts to speculate on the price of the underlying stock. If they believe the price of the stock will rise in the future, they can buy a contract that will allow them to lock into the price of the stock today. Since the contract itself is cheaper, investors view it as an easy financial commitment that can allow them access to expensive shares of stock.
Buying Call or Put
Investors can buy two types of stock option contracts: calls or puts. Buying calls or puts give the investor an opportunity to express his opinion on the stock’s direction. If the trader buys a call, he would have a right to access the shares at a fixed price (also known as the strike price), even if the stock is trading higher in the future. Alternatively, buying the put gives the trader the right to sell shares at the strike price, even if the stock becomes less valuable in the future.
Stock option contracts are bought and sold every weekday on the different exchanges in the U.S. Some common exchanges are the Chicago Board Options Exchange, the Boston Options Exchange, the International Securities Exchange and the New York Stock Exchange, to name a few. Investors can route orders to options exchanges to secure a contract and bet on the market direction of the underlying stock of that contract.
With the rise of many exchanges today, electronic trading applications are also enabling traders to get access to best prices of stock option contracts regardless of location. Traders can route a call or a put order contract to the exchange that is offering the best bid or offer prices. Even more, traders can also use electronic systems to implement complex strategies, which may involve buying more than one call or put at different strike prices, all with the click of a button.
Stock option contracts usually expire on the third Friday of every month. This means the investor who puts on a call option trade, for example, has to be confident about when or how long he expects the stock to rise. If he expects the stock to rise in a two months, he does not want to buy a contract that expires in a month. That call would expire worthless if the price rises only after the first month. Hence, it is good to align analytical predictions with the terms of the contract.
Victor Rogers is a professional business writer who started his career as a financial analyst on Wall Street. He later expanded his experience to content marketing for technology firms in New York City. Victor is an alumnus of St. Lawrence University, where he graduated with honors in economics and mathematics.