An option contract is definitely an agreement wherein the owner has got the right to buy or sell a security or an asset at a particular price on a fixed date in the future. Since the owner isn’t devoted to execute the obligation from the contract if he or she feels that it is disadvantageous.
There are two types of options contracts: call options and put options.
Basically, call options give the owner the authority to buy the underlying asset within the contract. Again, it is not an obligation.
For example, John and Tom agree on a call options contract wherein John will purchase from Tom, 100 shares (equivalent to one option) of Company A at $20 (strike price) what’s going to expire around the third Friday of April. The current cost of the share is $20.
In put options, the customer has the right to sell a good thing to the writer (the seller). Just like the call asset, it is bounded by a contract which states that the underlying asset is going to be sold in a particular price on a particular date. However the similarity ends there. In put options, the author has to purchase the underlying asset at the strike price when the buyer exercises this method.
Buying put options allows investors to earn money when cost of shares drops at the end of the contract.
Profit potentials are unlimited for that buyer of put options, particularly if the market begins to sell off. However, risks are limited when the market goes against them.
In reality, trading of options or transactions does not occur between two persons. Buying or selling sometimes happens without knowing the identity of the other party.
Options are only bought from 100 share lots. Therefore if the stock price is $20, you will have to pay $2,000 for every option contract plus the Option Premium.