Options are one of the most popular derivatives. There are highly leveraged instruments.
They can be used for hedging, speculation and arbitrage. Options derive their value from the underlying stocks, index, forex or other forms of assets.
An option is in simple terms a contract entered into two parties i.e.
a) buyer and
b) seller
In options, buyer is also called as holder and seller is called as writer.
The buyer/holder of options contract is granted a privilege to buy or sell a security at a specific price for a specific period.
The seller/writer of options contract assumes obligation to buy or sell a security at a specific price for a specific period. In futures, buyers and sellers both have the rights as well
obligations to buy or sell the security.
In options, buyer of options has rights but no obligations to honour his contract and seller has only obligations and no rights to honour his commitment. This is the main difference between futures and options. In options, buyer has a right to buy or sell a security and he has got an option to exercise his right or leave it. Hence the name “option”. As the price of the security keeps on fluctuating during the
life of an option, there is a risk for the seller. Hence the
buyer pays the seller a fee for granting this privilege. This is
called premium.