What Is a Stock Option?

What Is a Stock Option?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A stock option gives the holder the right, but not the obligation, to buy or sell a specific amount of shares at a predetermined price before an expiration date. So, if you have an option on certain shares, you can choose to buy or sell those shares at the agreed-upon price, regardless of the current market price. This can be a lucrative move is the market price is vastly different from your option price. However, if you choose not to exercise your option before the expiration date, the option becomes worthless. Stock options are a popular form of compensation for employees and a common investment opportunity.

Related Questions

1. How are stock options different from stocks?

While stocks give you a small piece of ownership in a company, stock options are contracts that give you the right to buy or sell the stock at a specific price before a set expiration date. With stock options, you’re leveraging your ability to profit from changes in the stock’s price, without actually owning the stock.

2. What are call and put options?

Want More Financial Tips?

Get Our Best Stuff First (for FREE)
We respect your privacy and you can unsubscribe anytime.

Call and put options are different types of stock options. A call option gives you the right to buy shares at a certain price before the option expires, while a put option gives you the right to sell shares at a specific price before expiration.

3. How can stock options benefit employees?

For employees, stock options can act as a form of incentive compensation. If the company’s share price increases above the option price, employees can buy shares at the option price and then sell them at the higher market price, making a profit.

4. What are the risks of trading stock options?

Trading options carries risk like any investment. If the stock price doesn’t move in the direction you anticipated, you could lose the entire amount you paid for the option. Moreover, options contracts have an expiration date, meaning if you don’t exercise them by a certain date, they become worthless.

5. How do I get started with trading stock options?

First, you need to have a brokerage account that allows options trading. Then, as with any form of trading, it’s pivotal to do your research, understand the risks, and potentially seek advice from financial advisors, before starting to trade options. Be sure you’re clear on the terms of the option and are comfortable with potential outcomes.