What Are Stock Options and How Do They Work?

Did you know that famous rapper Jay-Z boosted his net worth to more than $1 billion through stock investments?

It’s no surprise that so many entrepreneurs have started trading stocks as a means of making money. Clearly, it’s become a very lucrative market for many to get involved in.

When it comes to stock options, you might be left thinking: what are stock options and how do they work? Here, we’ll clear up the answers for you.

What Are Stock Options and How Do They Work?

When considering stock options, it’s important to know that there are two main types of options: puts and calls.

But first, let’s look at what stock options are.

What Are Stock Options?

Stock options allow an investor the opportunity to buy or sell stocks at a set price and on a fixed date.

The first option, puts, involves backing that a stock falls through—the second option, calls, bets that the price of a stock will increase.

A stock option has its shares forming its underlying asset, making these options equity derivatives.

Stock Options Explained

Stock options work as a contract between the buyer and seller. An agreement on the price is made as part of the contract being formed. The date is arranged, and the trade is set to take place usually a few months down the line.

The strike price is the price that the stock must rise to in order to make a profit. This is set during the writing of the contract.

How valuable the stock option will be is found by comparing the underlying stock price in relation to the strike price. This will leave you with the exercise price.

How Stock Options Work

Stock options come in two main styles: American and European. American options are more popular, and the traders can finalize the agreement any time between the start of the arrangement and the expiration date. On the other hand, traders can only finalize European options on the originally set expiration date.

With the strike price, the investor makes their trade decision based on the expected trends of the stock. If it’s assumed to rise by a certain amount at a specific time in the future, traders can set the strike price to match that price and date. You can discover more about the current stock market trends here.

The contract size depends on the number of shares one hopes to buy. A single contract is 100 shares. If a trader buys five contracts, and the price increases above the expected amount by the expiration date, 500 shares will be available for purchase.

Trading Stock Options

The selling of stock options depends upon the investment strategy that’s used.

If the trader assumes the strike price will rise, they have the choice: they can place a call or trade the put.

If they choose to trade the put, the seller will return a premium on the stock. But if the price of the stock option rises, it would become profitless, and the seller would be able to retain the full premium.

Should You Trade Stock Options?

Now that you’ve got your answer to the questions: what are stock options and how do they work; would you consider trading stock options?

Here, we’ve given you your stock options guide to help you decide. Remember that the stock market is dynamic and subject to change whatever you choose to do.