What are Stock Options?
Stock options are financial instruments that provide the holder with the right, but not the obligation, to buy or sell shares of a stock at a predetermined price within a specific time frame. They are often used as a form of employee compensation, allowing employees to purchase company stock at a future date at a locked-in price.
Types of Stock Options
- Call Options: These options give the holder the right to buy a stock at a set price before the option expires. Investors purchase call options when they believe the stock's price will rise.
- Put Options: These provide the holder the right to sell a stock at a predetermined price before expiration. Investors use put options when they anticipate a decline in the stock's price.
Key Components of Stock Options
- Strike Price: The predetermined price at which the holder can buy or sell the stock.
- Expiration Date: The date by which the option must be exercised or it becomes worthless.
- Premium: The price paid for the option itself, which is influenced by various factors including the stock's current price and volatility.
Benefits and Risks
Stock options can provide investors with leverage, potentially allowing for larger gains with a smaller initial investment. However, they also carry risks, including the possibility of losing the premium paid if the options expire worthless.