Purpose

Stocks Represent Ownership

Owning stock in a company represent a (usually) small percentage ownership of that company. Like many other assets, shares in a publicly-traded company have an ever-changing value established in the market. If there is a dividend, the owner of each share will receive it proportionally and periodically.

Options are Contracts on Stocks

Stock options are specific types of contracts relating to an underlying asset (a stock or an ETF). Options traded on an open market (i.e. different from employee stock options) have a market value derived from the underlying stock, so they’re called “derivatives.”

There are two general types of options: calls and puts. Call options are acquired by paying a price called the premium, to have the right (but not an obligation) to buy the underlying asset in the future at a predetermined price for a certain time. Put options are the same in the opposite direction, replacing the word “buy” with “sell.”

Options Done Right

Many investors beginning in options trades naturally view options as being similar to the underlying asset, thus tending to select cheap premiums with short time value and low probabilities. This strategy tends to produce results that seem akin to gambling, and cause options to have a reputation for being “high risk.”

There are better strategies.