WHAT ARE OPTIONS?

An option is a contract to buy or sell a stock, usually 100 shares of the stock per contract, at a premium price and by a certain week or month. Just as you can buy a stock because you think the price will go up or short a stock when you think its price is going to drop, an option allows you to bet on which direction you think the price of a stock will go. But instead of buying or shorting the asset outright, when you buy an option you’re buying a contract that allows but doesn’t obligate you to do a number of things, including:

• Buy or sell shares of a stock at an agreed-upon price (the “strike price”) for a limited period of time.
• Sell the contract to another investor.
• Let the option contract expire and walk away without further financial obligation.

Options trading may sound like it’s only for commitment folks and it can be if you’re simply looking to capitalize on short term price movements and trade in and out of contracts which we don’t recommend. But options are useful for long-term investors, too. Options are often used to hedge against your long term stock holdings when markets are very volatile or in a downtrend. Buying protective insurance via put options on stock ETFs is another way for minimizing the damage of falling stock prices. Put options are designed to increase in value when the underlying asset or ETF falls in price.