Option is a financial derivative representing sale of a contract from one party (known as a option writer) towards another party (known as a option holder). The contract gives the buyer a right for buying or selling a security or any other underlying financial asset as agreed in the option contract on a set date at a predetermined price. This predetermined price is called strike price. Option to buy is called call option and option to sell is called put option.
Options are flexible and can be put to different kinds of use. Traders utilize the options for speculation whereas hedgers use them for reducing their risk associated with holding a security for long.
Both, the option buyers as well as the writers believe to support and posses contrasting viewpoints and theories on the performance and functioning of an underlying asset.
To exemplify, an option provider needs to offer the shares underlying the security if the share price exceeds the set price (Strike Price). Thus, an option writer who moves on to selling for any call option possesses the belief that during the term of the option life, the underlying stock price will fall as compared to strike price. The option writer wants to earn profit through this mechanism.
An option buyer possesses a different and contradictory outlook. He believes that the price of an underlying security will continuously rise and hence he believes in buying it for a lower price and after then giving it out at profit.
Tags: financial derivative, option contract, option holder, option writer
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