OPTIONS & DERIVATIVES TRADING OPTIONS TRADING STRATEGY & EDUCATION
Options Contract
By MARSHALL HARGRAVE Updated September 03, 2021

Reviewed by MICHAEL J BOYLE

Fact checked by KIMBERLY OVERCAST
What Is an Options Contract?
An options contract is an agreement between two parties to facilitate a potential transaction on an underlying security at a preset price, referred to as the strike price, prior to or on the expiration date.
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Understanding an Options Contract
Options are financial instruments that are based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the chosen underlying asset at a price set out in the contract either within a certain timeframe or at the expiration date.
American options can be exercised any time before the expiration date of the option, while European options can only be exercised on the expiration date or the exercise date.
The terms of an option contract specify the underlying security, the price at which that security can be transacted (strike price), and the expiration date of the contract. In the case of stocks, a standard contract covers 100 shares, but the share amount may be adjusted for stock splits, special dividends, or mergers.
Options are generally used for hedging purposes but can be used for speculation, too. Options generally cost a fraction of what the underlying shares would. Using options is a form of leverage, allowing an investor to make a bet on a stock without having to purchase or sell the shares outright. In exchange for this privilege, the options buyer pays a premium to the party selling the option.
Types of Options Contract
There are two types of options contract: puts and calls. Both can be purchased to speculate on the direction of the security or hedge exposure. They can also be sold to generate income.
In general, call options can be purchased as a leveraged bet on the appreciation of a stock or index, while put options are purchased to profit from price declines. The buyer of a call option has the right, but not the obligation, to buy the number of shares covered in the contract at the strike price. Put buyers, on the other hand, have the right, but not the obligation, to sell the shares at the strike price specified in the contract.
Option sellers, also known as writers, are obligated to transact their side of the trade if a buyer decides to execute a call option to buy the underlying security or execute a put option to sell.
Example of an Options Contract
Company ABC's shares trade at $60, and a call writer is looking to sell calls at $65 with a one-month expiration. If the share price stays below $65 and the options expire, the call writer keeps the shares and can collect another premium by writing calls again.
If, however, the share price appreciates to a price above $65, referred to as being in-the-money (ITM), the buyer calls the shares from the seller, purchasing them at $65. The call-buyer can also sell the options if purchasing the shares is not the desired outcome.
Related Terms
How a Put Works
A put option gives the holder the right to sell a certain amount of an underlying at a set price before the contract expires, but does not oblige him or her to do so. more
What Is Quadruple Witching?
Quadruple witching refers to a date on which stock index futures, stock index options, stock options, and single stock futures expire simultaneously. more
Non-Equity Option Definition
A non-equity option is a derivative contract with an underlying asset of instruments other than equities.more
What Is an Outright Option?
An outright option is an option that is bought or sold individually, and is not part of a multi-leg options trade. more
What Is a Stock Option?
A stock option gives an investor the right, but not the obligation, to buy or sell a stock at an agreed-upon price and date. more
Vanilla Option Definition
A vanilla option gives the holder the right to buy or sell an underlying asset at a predetermined price within a given time frame. more
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