Option

A contract that gives the buyer the right — but not the obligation — to buy or sell 100 shares of a stock at a fixed price before a set expiration date.

An option is a contract between two parties. The buyer pays a premium for the right to act; the seller collects that premium and takes on the obligation to fulfill the contract if the buyer exercises. The key word is "right" — unlike a futures contract, the option buyer can walk away and lose only the premium paid.

Every standard equity option covers 100 shares. A single contract trading at $2.50 costs $250 (2.50 × 100), not $2.50. Options expire on specific dates — most commonly the third Friday of each month — and become worthless after expiration if not exercised.

Options were invented as risk-management instruments, not speculation tools. A farmer selling wheat in November might buy put options to lock in a minimum price for their harvest. An institution holding millions in equities buys puts to hedge against a decline. The same instruments that pension funds use for capital protection are also the instruments retail traders use to buy lottery-ticket-style weekly calls before earnings — same tool, completely different intention and outcome.

This definition is for informational and educational purposes only. Nothing on Finance Compass constitutes financial, investment, or trading advice. Always conduct your own research and consult a qualified professional before making financial decisions.