An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset. The assets can range from stocks to bonds in which the buyer has the right to purchase these assets at a certain price and date. There are two types of options:
Call: A call option gives the holder the right to buy an asset at a certain price within a specific time period.
Put: A put option gives the holder the right to sell the asset as a certain price within a specific time period.
Example ( Investopdia):
For example, you discover a house that you’d love to purchase. Unfortunately, you won’t have the cash to buy it for another three months. You talk to the owner and negotiate a deal that gives you an option to buy the house in three months for a price of $200,000. The owner agrees, but for this option, you pay a price of $3,000.
It’s discovered that the house is actually the true birthplace of Elvis! As a result, the market value of the house skyrockets to $1 million. Because the owner sold you the option, he is obligated to sell you the house for $200,000. In the end, you stand to make a profit of $797,000 ($1 million - $200,000 – $3,000).
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