OK let’s take a few steps back to the very beginning.
Most investors know that buying common stock entitles them to a part ownership in the company issuing those shares. This means that you have entered into an “equity” participation in the company and in most cases gives the owner of stock the right to dividends paid by the company from time to time and entitles you to a vote in company affairs.
On many companies listed on the world’s stock exchanges, you are also able to trade options. So what is an option?
An option is actually a contract, which gives the owner of the option, the right to buy or sell parcels of shares in a particular company. In this case, these are often referred to as “stock options”, however options can also be traded on ETFs, futures contracts and a number of other instruments. Within the context of this course, I will generally be referring to stock options unless otherwise stated.
It should be noted that options issued by the company to its executives as incentives (and sometimes the subject of controversy) or non-standardized company options traded on some stock exchanges are also called stock options, but these are not included within the context of this course. We are learning specifically about “exchange traded options”
An option does not convey any ownership in the underlying security at all, merely the right to buy or sell a particular security. An option is termed as a “derivative” security, as any value it may have is derived from the value of the underlying security.
Next - Options Are Standardized Contracts