Option, in general, is the price possibility of the future events.
Let’s assume that there is a land for sale for $100,000 and you want to buy this land because you think it will cost $110,000 in 1 month. Essentially you’re risking $100,000 to make $10,000. Instead of doing that you can buy the Right to buy this land for $100,000 in 1 month, an option contract, and this option contract costs only $2,000 at the moment. So, in 1 month, if the price of the land is indeed $110,000 you can exercise this contract option and buy this land for $100k and immediately sell it for $110k, making $10,000 – $2,000(the cost of contract) = $8,000 in the process. However if the price of the land has fallen to $80,000 in 1 month you can just say forget it, I lost my 2k and I move on. So Option Contracts allow you to maximize your returns and reduce your risk. Stock options work in the similar way.
Introduction to stock options
One option represents 100 shares of the underlying security. If you sell an option relating to IBM, then IBM will be the underlying stock for that contract. The contract would be to either buy or sell one hundred shares of IBM stock. Options can be bought or sold at any time on the stock market. The more likely the price is to occur, the more expensive an option would be.
If you own a call option, you have the right, but not the obligation, to buy the underlying stock at the strike price at which you purchased the call option. If you own (bought) a put option, you have the right, but not the obligation to sell the underlying stock at the strike price at which you purchased the put option.
There is a number of good books that explain options. One of our favorites is “McMillan on Options” by Lawrence McMillan.