An option is an investor's way of making a bet that the price of a stock will go up (a call option) or down (a put option).
Options investors usually set boundary conditions, meaning a maximum and minimum price for the “underlying asset” (such as a stock) for the call or put options. The investor would most likely set the maximum value as the current price of the stock. If that price is greater than the call option boundary, the investor would not exercise the option, since he or she would lose money paying the current market price.
Same deal, more or less, for put options. If the price of the stock stays above your lowest boundary, you would not exercise the option, since you're waiting for it to drop down to a given price.
Let’s say you have your eye on the stock for Desktop Throwbacks, LLC, and are willing to buy if it goes down to $25. You could sit around and wait for this to happen (sounds relaxing), but a better use of your money might be to sell a put option, setting the boundary at the current market price of $28.
If the price stays at or above $28, the option buyer would not force you to pay that amount, and the option would expire. If it does go down to $25, you get the shares at the price you wanted. Yippee.
Related or Semi-related Video
Finance: What's the Difference Between a...13 Views
Finance a la shmoop what's the difference between an American and a
European-style stock option okay if you clicked to [Man talking]
watch this video we're gonna assume you know what an option is if not well then
our video on it which won a Palme-d'Oy Vey-at con awaits alright well this [People chanting at Palme d'Oy Vey]
video is about one thing only a date not brought to you by tinder.. American
options can be converted anytime they are owned until they expire which in the
US usually happens on the third Friday of each month
aka expiration Friday that is the November 50 strike calls expire at the [Calendar flicks]
end of the trading day on the third Friday of this coming November it's just
easier having them all expire on the same day saves a lot of you know date
writing and yeah we thought the same thing thank goodness they don't sell [Green eggs on a shelf]
eggs that way ok so that's an American style option - A European style option is
different in one key way other than you know all the socialism and centuries of
espresso and wine and tea development behind it [People pouring tea, wine and espresso]
European options can only be converted and expire on one day so if that day
comes along in well North Korea decides to get all balmy or nuki and the market
goes down a lot well then you're out of luck at least if you had call options [Stock market dropping]
who were hoping to make money from because the market would go down right
well the fact that it's only one day when you can sell is in large part a
reflection of the very low tech manual labor systems in place when the whole [Person scribbling on piece of paper]
call option world was put into place in Britain like a hundred years ago the
American system was run largely by computers from a very early time in its [Person using computer]
history ie it was much later than when the Brits started and you can imagine
that if you leave open the potential for trading options at any time during a [Trade transferring between people]
given period well it leaves massively more data entry and data management
duties then if all the fireworks happen on one day so you really do need [Fireworks going off in the sky as window is open]
computers to manage all that stuff and it of course leaves the market open to a
whole lot more corruption manipulation and control from the
you know powers-that-be so do they sell options on being Queen,
King, Joker yeah when and how would they expire...[Man throws away King and Joker cards]
Up Next
What is a put option? A put option is a type of contract that lets the investor sell shares of a stock at a certain price and within a window of ti...
What is a call option? A call option is a type of contract that lets the investor buy shares of a stock at a certain price and within a window of t...
The intrinsic value of an option is the share price of a stock minus its strike price - i.e. the "in the money" amount.