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An option is a financial contract which gives the buyer the right to buy certain assets on a predetermined date and price in the future. It is a little bit similar than future contracts with the difference that in case of options there is only a promise to buy; in contrary to futures where the buyer has the obligation to buy.
In terms of investment you can buy or sell options on stocks, indices and currencies.

Options is a kind of investment with a high risk and can give you a lot of money but there is also a great risk that you lose a lot of money. It is surely not recommended for everyone, don't start with it if you don't have enough knowledge of the stock market and even then the risk is very high. Nobody knows with certainty that the stocks are going to raise or drop during the term of your option contract.

There are two kinds of options: calls and puts:
- A call gives the buyer the right to buy on a predetermined price and within the period of the contract.
- A put gives the buyer the right to sell on a certain price and within the period of the contract.

Buyers are called "holders" in case of options; the sellers are called writers. Holders have the right to buy but writers have the obligation to sell. If you buy an option you need to pay a premium. The holder expect that the value of the stocks will rise above the price of the stocks included the premium they paid. If the value of the stocks drop the holder is not going to buy the stocks and the profit of the writer is the premium.

An example:
- You buy a call option contract for 3 months of 100 shares of a certain company with a value of $40.00 for one stock. The premium is $1.50. You will pay $1.50 X 100 = $150.00 (this is the premium). After two months the price of one share is $50.00 you can exercise your option because you have a profit of $(50.00 41.50) X 100 = $850.00; this is 20,48 % above the price included the premium. You can sell them now on the market with a profit of $8.50 for each share or you can keep them knowing that you bought them now with a discount of $20,48 % of the current value.

- You buy a put option contract for three months of 100 shares of a certain company with a value of $100.00 for each share. The current price is $105.00. The difference between both is the premium which the holder pays to the writer. After one month the price of one share is $85.00; you can exercise your option because you can buy the shares for $85.00 and sell them for $100.00. Your profit will be $10.00 ($15.00- $5.00) for each share. ($5.00 is the premium which you paid). Your total profit is $1.000.00 (100 shares)

Keep in mind it looks that you can easy earn a lot of money but the risk of losing is often higher. Who knows if shares are going to raise or drop?

Learn more about this author, Erik Van Tongerloo.
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