Eli5: what are options in stock trading?
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Option is slang for “options contract”
It is an agreement for one individual to buy or sell a certain amount of stock at a fixed price, if they take the option to execute it, within a predetermined amount of time.
Let’s say stock X is trading at $10. You think the price will go up. You could buy a call option for 100 shares with a strike price of $11 that expires in thirty days. That means if you exercise the option you will buy 100 shares at $11 each. You will pay a small premium of a few dollars when agree to the options contract, but the option will expire worthless in thirty days if the price doesn’t reach $11.
Why would you want to do this instead of just buying 100 shares at $10 each? Well the reason is that you can take the cash equivalent of the option value instead of actually excersing it. That means if the price reaches $12, you don’t actually have to spend $1100 on $1200 of stock. You can just take the $100 difference. This lets a trader “control” a large amount of stock with substantially less capital for the price of the options contract.
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