The terms, decoded

What is an option?

An option is a contract that gives you the right — but not the obligation — to buy or sell 100 shares of a stock at a fixed price by a fixed date, in exchange for a small upfront payment.

That sentence packs a lot, so unpack it: 100 shares because options trade in standard lots; a fixed price (the strike) because the contract locks it in regardless of what the stock does later; a fixed date (the expiry) because the right doesn't last forever; and the small upfront payment is the premium — the only money the buyer puts at risk. Two flavours exist: a call gives the right to buy, a put gives the right to sell. From the seller's side, every option is a promise — the seller takes the premium and accepts the obligation to honour the contract if the buyer chooses to exercise it.

What's a derivative?

A derivative is a financial contract whose value derives from something else — and an option is one of the most common derivatives, with the “something else” being an underlying stock.

Owning a share of a stock means owning a tiny piece of the company itself — you get dividends, voting rights, and a claim on whatever the company is worth. Owning an option doesn't give you any of that. The option is a separate contract that tracks the stock's price without being the stock; think of it like a deposit on a house versus owning the house — the deposit's value moves with the house, but it isn't the house. Other common derivatives include futures, swaps and forwards; options are the one most retail traders meet, and almost everything in this glossary is about how that one contract behaves under different conditions.