Option trading allows you to speculate whether an asset’s price will rise or fall from its current price, how much an asset’s price could rise or fall, and by what date these price changes will occur.

Like forwards and futures, they’re financial derivatives whose value is dependent on an underlying asset. Stock options give the owner the right -- but not any obligation -- to buy or sell a stock at a certain price by a certain date, but they do not obligate investors to execute the contract.

The person who buys options are called holders (or owners), while those who sell them are referred to as writers. Holders do not have an obligation to execute the contract, but writers are required to buy or sell the stock if the option they wrote is exercised against them.

Because they are derivative securities, options themselves are inherently worthless if decoupled from the underlying asset.

There are two basic types of options contracts:

• Put options, which have a bearish buyer and a bullish seller. If you buy a put option, you earn the right to sell 100 shares of the stock.
• Call options, which have a bullish buyer, who believes the market will go up, and a bearish seller, who believes the market will go down. If you buy one call option, you have the right to buy 100 shares of the specified security.

The option's specified price is called the strike price. The date on the option is its expiration date. The price you pay for the contract is called the premium. The standard number of shares an options contract confers the right to buy or sell is 100.

If an option has a premium of 35 cents per contract, buying one option costs $35 ($0.35 x 100 = $35). The premium is partially based on the strike price or the price for buying or selling the security until the expiration date.

If an investor buys a call option and the stock's price increases to above the strike price before the option's expiration date, then the investor can exercise their option to buy the stock at the strike price and resell it at the higher market price for a profit.

If, instead, an investor buys a put option and the stock's price decreases to below the strike price before the put option's expiration date, then the investor can exercise their option to sell the stock at the strike price and repurchase it at the lower market price.

When trading options, first determine whether shares are overvalued or undervalued. If you believe shares are undervalued, buy a call option expiring at some point in the future when you think the market will realize the true value of the shares. If you think they're overvalued, buy a put option.

If you buy a call or put option, the most you can lose is the premium you paid for the option. That happens when the option expires worthless.

If you sell a put option, the most you can lose is the strike price of the contract multiplied by 100 for each contract you sold. That's offset by the premium you collect from originally selling the share. This can happen if the stock goes to $0 per share before your contract expires. You'd be forced to buy worthless shares at your strike price.

However, if you sell a call option, you potentially face unlimited losses. The stock price can go up to an indeterminate amount, and you'll be on the hook for selling shares well below their market value.

The option holder can generate income when they buy call options or become an options writer. The benefit of selling options is the option premium that is collected from the buyer. Option writers are often betting that the option won't be exercised against them, allowing them to keep the money they received from writing the option.

Investors use options strategies in their portfolios for flexibility, leverage, hedging, and income generation.  Depending on the underlying security’s price and the time remaining until expiration, an option is said to be in-the-money (profitable) or out-of-the-money (unprofitable).