Options

From Wikinvestor

An option is a contract written by a seller that conveys to the buyer the right — but not the obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a particular asset, such as a piece of property, or shares of stock or some other underlying security. In return for granting the option, the seller collects a payment (the premium) from the buyer.

For example, buying a real estate option provides the right to buy a specified property of a security at a set price at some time on or before expiration. Upon the option holder's choice to exercise option the option, the party who sold, or wrote, the option must fulfill the terms of the contract.

Historical uses of options

Contracts similar to options are believed to have been used since ancient times. In the real estate market, call options have long been used to assemble large parcels of land from separate owners, e.g. a developer pays for the right to buy several adjacent plots, but is not obligated to buy these plots and might not unless he can buy all the plots in the entire parcel. Film or theatrical producers often buy the right — but not the obligation — to dramatize a specific book or script.

Mortgage borrowers have long had the option to repay the loan early, which corresponds to a callable bond option.

Privileges were options sold over the counter in nineteenth century America, with both puts and calls on shares offered by specialized dealers. Their exercise price was fixed at a rounded-off market price on the day or week that the option was bought, and the expiry date was generally three months after purchase. They were not traded in secondary markets.