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An option is a contract that gives the buyer the right — but not the obligation — to buy or sell an underlying asset at a specific price, on or before a certain date. This is known as the “strike” price. This means that you don’t have to invest directly in the asset. An option you own is “exercised” if you buy or sell the underlying asset at the strike price. It means you are acting on your right to buy or sell an underlying asset such as currencies, bonds, exchange traded funds (ETFs), indices, stocks, and others.

Some options are “cash settled.” Instead of a purchase or sale of the underlying asset on exercise, a payment is made either from the seller to the buyer or vice-versa based on the change in value of the underlying asset.

Stock options will be used as an example to illustrate.

There are two types of options:

1. Call options – gives you the right to buy a stock at the strike price by a certain date.

You buy a call option if you think the price of the stock is going to rise.

At the expiry date:

• If the option is in-the-money, meaning the market price of the stock is higher than the strike price, if you don’t do anything, generally it will be exercised automatically for you, but you should confirm with your broker if this is the case.
• If the option is out-of-the-money, meaning the market value of the stock is below the strike price, the option will expire worthless and the premium (the amount you paid for the option) is forfeited.

2. Put options – gives you the right to sell a stock at the strike price by a certain date.

You buy a put option if you think the price of a stock that you own will fall.

• If the stock rises in value above the strike price, you can sell your shares for a profit and let the put option expire worthless.
• But if the price falls below the strike price, you can exercise the put option and sell the stock at the higher price specified by the put option.

When you own an option, you exit the position in one of three ways:

1. Option expires in-the-money, generally resulting in an exercise of the option (purchase or sale of the underlying asset at the strike price).
2. Option expires out-of-the-money with no remaining value.
3. Option (which may or may not be in-the-money at the time) is sold to another market participant before expiry (known as sell to close).

Note that if you are the writer (seller) of the options contract you are obligated to buy or sell the underlying asset should the option holder (buyer) exercise their right under the option contract.

All investments carry some level of investment risk — however, some investments have more risk than others. Before you choose your investments, understand your risk tolerance, and the relationship between risk and return. Do your research and if you need advice speak with a qualified professional.