Eli5: what are options in stock trading?
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Let’s say you need to buy a lot of gas in a few weeks for a potential trip to the lake. You need to gas up a few cars, maybe your boat, and some ATVs. The price of gas has been going up and down in your community and you’re nervous about the possibility that the price of gas is going to go up in a few weeks. You don’t want to buy the gas now because you don’t have any place to store it.
What you need is someone willing to take some of that risk from you, almost like insurance, so that you can pay them for the *option* to buy gas at the price you’re willing to pay.
They might sell you, for $50, the *option* to buy 200 gallons for $600 in 3 weeks. They are betting that the price of gas won’t go too much higher than that. If it does, then they lose money. If it doesn’t, then at least they get the $50.
So when the time comes for your trip, you can now choose to exercise the option or not. If the price of gas falls below what your option says you can buy it at, then you don’t need to exercise it and you can let it expire. You’re out the $50. But if it goes above the price, you can exercise the option and get the gas at the negotiated price.
You might also be able to buy and sell options. Imagine that the price of gas is going up, but you realize you can’t take your trip after all. When you lament to your neighbor, she says that they were planning on going on their own trip at the same time and they could really use the gas. Since prices are higher, there’s more of a chance that your option will save them money, so they agree to buy it from you for $75. You’ve made $25 in profit and they now have guaranteed gas at a reasonable price.
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