Before you start any options trading or even think about it, you should first know the fundamental facts and various factors related to options.
In financial terms, an option is a contract entered into by two parties.
One party is the seller and the other party is the buyer in options terminology.
Under the option trading contract, the buyer holds the right to buy or sell a mutually agreed upon asset at the agreed price, on or before a particular date.
The asset that is traded is known as the underlying asset.
The agreed price is termed as the strike price.
However, the buyer is not under any particular obligation to buy or sell and the buyer might choose not to act upon the agreement.
If this happens, the seller is entitled to collect a payment from the buyer in lieu of the option and this payment is called the premium.
There are two types of options in option trading.
One is known as call option and the other is called as put option.
The buyer has the right to buy the agreed upon asset under the call option, while the put option gives the buyer the right to sell the asset.
According to the options trading agreement, the seller must buy or sell the underlying asset at the price that had been agreed upon.
However, the buyer possesses the option of choosing to forego the right and allowing it to expire.
In such a case, the premium amount collected by the seller remains with the seller and the buyer loses the right to it.
The underlying asset can be any security, such as a bond or a stock, a piece of property, or a derivate instrument like a futures contract.