WHAT IS AN OPTION?
Plain English
Think of an option like a reservation. You pay a small fee to reserve the right to buy a house at a set price for the next 90 days. If the house value goes up, your reservation is valuable. If it goes down, you just walk away and only lose your reservation fee.
Going deeper
An option is a derivative contract whose value is derived from an underlying asset, typically a stock or ETF. It gives the buyer the right, but not the obligation, to buy (a Call) or sell (a Put) 100 shares of the underlying stock at a specified price (Strike Price) before a specified date (Expiration Date). The seller (writer) of the option takes on the corresponding obligation to fulfill the contract if the buyer exercises their right. To acquire this right, the buyer pays the seller a fee called the Premium. Options are standardized contracts traded on regulated exchanges, and each contract represents 100 shares of the underlying stock.
Examples
Buying a Call Option
SPY is trading at $100. You buy one SPY 105 Call expiring in 30 days for $2.00 per share ($200 total). This gives you the right to buy 100 shares of SPY at $105 any time before expiration. If SPY rises to $112, you could exercise and buy shares at $105, or simply sell the option at a profit. If SPY stays below $105, the option expires worthless and you lose the $200 premium.
Buying a Put Option
SPY is trading at $100. You buy one SPY 95 Put expiring in 30 days for $1.50 per share ($150 total). This gives you the right to sell 100 shares of SPY at $95. If SPY drops to $88, you could exercise and sell shares at $95, or sell the option at a profit. If SPY stays above $95, the option expires worthless and you lose the $150 premium.