Simply stated, a stock option is "a contract that gives the holder the right to either buy or sell the underlying stock at a specific price on or before the expiration date." There is a lot of information in that statement alone, so we will break down word for word to find out exactly what the definition means.
Contract - a stock option contract controls 100 shares of the underlying stock. This key word is control. You do not actually own the stock, but you are able to control 100 shares of it.
The right to buy or sell - this is the main concept behind how options work. When you purchase an option, you have the right to either buy the stock (call options) or sell the stock (put options). Since one contract controls 100 shares, you have the right to either buy or sell 100 shares of the stock. We will go into more details about how call and put options work.
Specific price - this is known as the strike price. These are predetermined stock price levels where the option trader can purchase their options. Strike prices are usually listed in increments of 5, for example, $60, $65, $70,... Your broker will list the specific strike prices for each stock under what is called "option chains."
Expiration date - options expire on the 3rd Saturday of every month, but the last day to trade them is the Friday before. So most people typically say expiration is the 3rd Friday of every month. There are options of different months for you to choose from. For example, if you purchase an option for December 2008, that means your options will expire on the 3rd Friday of December 2008. When your options expire, you no longer have the rights to exercise. Options are also known as "wasting assets" because for each day that passes, a little portion of your option value will decrease due to time decay.
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