Options give you the right, but not the obligation, to buy or sell an asset at a predetermined price and date. Therefore, options can help you lock in a future price for valuable assets, such as stocks and bonds. While, in theory, you can sell an option after you buy it, this may or may not be easy, depending on the type of option you purchased.
An option locks in a future price without mandating a transaction. A call option gives you the right, but not the obligation, to buy an asset, while a put option allows you to sell. For example, a call option may be for 100 shares of Microsoft with a strike price of $40, expiring on December 1. This means that, if you desire, you can purchase 100 Microsoft shares from the person specified in the option contract as the seller, at $40 apiece on December 1. Today, most options exist as electronic entries, and the seller's name is contained in the database of the option exchange. In a customized, "over-the-counter" (OTC) option, there is usually a written contract bearing the seller's name. You would exercise this option if Microsoft is trading at more than $40 per share. If you can buy Microsoft for less in the stock market, you'd not exercise the option, letting it expire.
Since the option-holder is in the privileged position of exercising the option only if it is profitable to do so, the option is a valuable asset. You must therefore pay money to the option's writer to obtain this privilege. Once you purchase the option from the writer, you can wait until the expiration date to decide whether you wish to exercise it, or you can transfer this privilege to someone else (in other words, sell the option). Employee stock options are an exception, however. These options allow employees to buy company stock and are provided free of charge as a form of compensation. They can usually not be sold or otherwise transferred to others.
To streamline the process of buying and selling options, numerous exchanges throughout the world allow investors to trade options just like stocks. On The Chicago Board of Options Exchange (CBOE), for example, options change hands just like stocks do in the New York Stock Exchange (NYSE). You can access, free of charge, the last trading price of various options and see how many of each option changed hands. To sell your option on the CBOE or any other exchange, all you need to do is place a sale order through your broker. However, not every imaginable option is traded on an exchange, just as not every stock is listed in one of the stock markets.
If you need to purchase an option that is not one of the standard types traded in an options exchange, you must ask an options dealer to write a customized option for you. Such an option can involve the stock of a small company, or you may need an expiration date many years in the future. Once you purchase this kind of option, it will be difficult to sell it, as you cannot simply place an order through a broker to sell it in an exchange. You will have to find an interested buyer through your own efforts, which may be very difficult or impossible. In some cases, the party who wrote the option may be willing to buy it back from you, which would revoke the option writer's obligation and essentially cancel the option. However, in most cases, you will be stuck with the option.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.