What is an Option?

An option is simply a contractual agreement between two parties, the buyer and the seller. The contract gives the right to the buyer of the option to buy/sell a certain number of the underlying asset from seller of the option at the exercise (strike) price within a specified time in the future.

The buyer of the option has the right but not the obligation to buy or sell the underlying asset within the specified time.

The seller of an option does not have such rights and can only assume the obligation as stipulated in the contract.

An Example

When purchasing a new car, you would have to purchase precautionary insurance plans before driving in it.

When you purchase an insurance policy — be it an automobile, health, life or homeowner’s insurance — you will need to pay a premium for the protection it provides.
This mimics that of an option buyer.

However, just like what we experience in life, we end up not putting the insurance to use, resulting in the profiting of the Insurance firm,
This mimics that of an Option Seller

Futures vs Options