Home > Articles > Business & Management > Finance & Investing

This chapter is from the book

The Definition of an Option

An option is defined as the “right, not the obligation, to buy (or sell) an asset at a fixed price before a predetermined date.”

Let’s have a look at that definition and see if we can pick out the component parts:

  • the right, not the obligation
  • to buy or sell an asset
  • at a fixed price
  • before a predetermined date

These component parts have important consequences on the valuation of an option. Remember that the option itself has a value, which we look at after we finish with the definitions.

Before we go ahead and look at the ways in which options are valued, let’s consider the words, “right, not the obligation.”

The Right, Not the Obligation

Buying Gives You the Right

  • Buying an option (call or put) conveys the right, not the obligation, to buy (call) or sell (put) an underlying instrument (for example, a share).
  • When you buy an option, you are NOT obligated to buy or sell the underlying instrument—you simply have the right to do so at the fixed (exercise or strike) price.
  • Your risk when you buy an option is simply the price you paid for it.

Selling (Naked) Imposes the Obligation

  • Selling an option (call or put) obliges you to buy from (with sold puts) or deliver (with sold calls) to the option buyer if he or she exercises the option.
  • Selling options naked (for example, when you have not bought a position in the underlying instrument or an option to hedge against it) gives you an unlimited risk profile.

Combined with the fact that you are obliged to do something, this is generally NOT a preferable position in which to put yourself. Only advanced traders should contemplate selling naked options, and even then they should have a protective strategy in mind to cover the downside (see Figure 1.1).

Now let’s consider the words, “to buy or sell an asset.”

Types of Options—Calls and Puts

A call is an option to BUY.

A put is an option to SELL.


  • A call option is the right, not the obligation, to BUY an asset at a fixed price before a predetermined date.
  • A put option is the right, not the obligation, to SELL an asset at a fixed price before a predetermined date.

Types of Calls and Puts

Options can be either American-style or European-style:

  • American-style options allow the option buyer to exercise the option at any time before the expiration date.
  • European-style options do not allow the option buyer to exercise the option before the expiration date.

Most traded options are American-style, and all U.S. equity options are American-style.

American-style options are slightly more valuable than European-style options because of their added flexibility. It is logical that being able to exercise before expiration must be more valuable than not being able to.

As a rule, stock options are generally American-style. Futures options are generally European-style.

Diagram 1.1. • American- and European-style options.

Now we need to look at the words, “at a fixed price.”

Exercise (or Strike) Price

The exercise (strike) price is the fixed price at which the option can be exercised.

So if you buy a call option that has a strike price of 50, then you have bought yourself the option to buy the asset at a price of $50.

However, in the real world, you want to exercise your right to buy that asset only at $50 if the underlying asset is actually worth MORE than $50 in the market. Otherwise, there would be no point. It would mean buying the asset for $50 when it’s only actually worth, say, $40 in the marketplace. No one would do that because they could buy it for $40 in the market.

This leads us to the words, “before a predetermined date.”

Expiration Date

This is the date before which the option can be exercised.

At expiration, the call option’s own value is worth only the price of the asset less the strike price, and at expiration, the put option’s own value is only worth the strike price less the price of the asset. For U.S. equity monthly options, the expiration dates fall on the Saturday after the third Friday of every month. Weekly options have gained in popularity, but they are still not quite as actively traded as the traditional monthly options.

This leads us onto the topics of intrinsic value and time value.

InformIT Promotional Mailings & Special Offers

I would like to receive exclusive offers and hear about products from InformIT and its family of brands. I can unsubscribe at any time.


Pearson Education, Inc., 221 River Street, Hoboken, New Jersey 07030, (Pearson) presents this site to provide information about products and services that can be purchased through this site.

This privacy notice provides an overview of our commitment to privacy and describes how we collect, protect, use and share personal information collected through this site. Please note that other Pearson websites and online products and services have their own separate privacy policies.

Collection and Use of Information

To conduct business and deliver products and services, Pearson collects and uses personal information in several ways in connection with this site, including:

Questions and Inquiries

For inquiries and questions, we collect the inquiry or question, together with name, contact details (email address, phone number and mailing address) and any other additional information voluntarily submitted to us through a Contact Us form or an email. We use this information to address the inquiry and respond to the question.

Online Store

For orders and purchases placed through our online store on this site, we collect order details, name, institution name and address (if applicable), email address, phone number, shipping and billing addresses, credit/debit card information, shipping options and any instructions. We use this information to complete transactions, fulfill orders, communicate with individuals placing orders or visiting the online store, and for related purposes.


Pearson may offer opportunities to provide feedback or participate in surveys, including surveys evaluating Pearson products, services or sites. Participation is voluntary. Pearson collects information requested in the survey questions and uses the information to evaluate, support, maintain and improve products, services or sites, develop new products and services, conduct educational research and for other purposes specified in the survey.

Contests and Drawings

Occasionally, we may sponsor a contest or drawing. Participation is optional. Pearson collects name, contact information and other information specified on the entry form for the contest or drawing to conduct the contest or drawing. Pearson may collect additional personal information from the winners of a contest or drawing in order to award the prize and for tax reporting purposes, as required by law.


If you have elected to receive email newsletters or promotional mailings and special offers but want to unsubscribe, simply email information@informit.com.

Service Announcements

On rare occasions it is necessary to send out a strictly service related announcement. For instance, if our service is temporarily suspended for maintenance we might send users an email. Generally, users may not opt-out of these communications, though they can deactivate their account information. However, these communications are not promotional in nature.

Customer Service

We communicate with users on a regular basis to provide requested services and in regard to issues relating to their account we reply via email or phone in accordance with the users' wishes when a user submits their information through our Contact Us form.

Other Collection and Use of Information

Application and System Logs

Pearson automatically collects log data to help ensure the delivery, availability and security of this site. Log data may include technical information about how a user or visitor connected to this site, such as browser type, type of computer/device, operating system, internet service provider and IP address. We use this information for support purposes and to monitor the health of the site, identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents and appropriately scale computing resources.

Web Analytics

Pearson may use third party web trend analytical services, including Google Analytics, to collect visitor information, such as IP addresses, browser types, referring pages, pages visited and time spent on a particular site. While these analytical services collect and report information on an anonymous basis, they may use cookies to gather web trend information. The information gathered may enable Pearson (but not the third party web trend services) to link information with application and system log data. Pearson uses this information for system administration and to identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents, appropriately scale computing resources and otherwise support and deliver this site and its services.

Cookies and Related Technologies

This site uses cookies and similar technologies to personalize content, measure traffic patterns, control security, track use and access of information on this site, and provide interest-based messages and advertising. Users can manage and block the use of cookies through their browser. Disabling or blocking certain cookies may limit the functionality of this site.

Do Not Track

This site currently does not respond to Do Not Track signals.


Pearson uses appropriate physical, administrative and technical security measures to protect personal information from unauthorized access, use and disclosure.


This site is not directed to children under the age of 13.


Pearson may send or direct marketing communications to users, provided that

  • Pearson will not use personal information collected or processed as a K-12 school service provider for the purpose of directed or targeted advertising.
  • Such marketing is consistent with applicable law and Pearson's legal obligations.
  • Pearson will not knowingly direct or send marketing communications to an individual who has expressed a preference not to receive marketing.
  • Where required by applicable law, express or implied consent to marketing exists and has not been withdrawn.

Pearson may provide personal information to a third party service provider on a restricted basis to provide marketing solely on behalf of Pearson or an affiliate or customer for whom Pearson is a service provider. Marketing preferences may be changed at any time.

Correcting/Updating Personal Information

If a user's personally identifiable information changes (such as your postal address or email address), we provide a way to correct or update that user's personal data provided to us. This can be done on the Account page. If a user no longer desires our service and desires to delete his or her account, please contact us at customer-service@informit.com and we will process the deletion of a user's account.


Users can always make an informed choice as to whether they should proceed with certain services offered by InformIT. If you choose to remove yourself from our mailing list(s) simply visit the following page and uncheck any communication you no longer want to receive: www.informit.com/u.aspx.

Sale of Personal Information

Pearson does not rent or sell personal information in exchange for any payment of money.

While Pearson does not sell personal information, as defined in Nevada law, Nevada residents may email a request for no sale of their personal information to NevadaDesignatedRequest@pearson.com.

Supplemental Privacy Statement for California Residents

California residents should read our Supplemental privacy statement for California residents in conjunction with this Privacy Notice. The Supplemental privacy statement for California residents explains Pearson's commitment to comply with California law and applies to personal information of California residents collected in connection with this site and the Services.

Sharing and Disclosure

Pearson may disclose personal information, as follows:

  • As required by law.
  • With the consent of the individual (or their parent, if the individual is a minor)
  • In response to a subpoena, court order or legal process, to the extent permitted or required by law
  • To protect the security and safety of individuals, data, assets and systems, consistent with applicable law
  • In connection the sale, joint venture or other transfer of some or all of its company or assets, subject to the provisions of this Privacy Notice
  • To investigate or address actual or suspected fraud or other illegal activities
  • To exercise its legal rights, including enforcement of the Terms of Use for this site or another contract
  • To affiliated Pearson companies and other companies and organizations who perform work for Pearson and are obligated to protect the privacy of personal information consistent with this Privacy Notice
  • To a school, organization, company or government agency, where Pearson collects or processes the personal information in a school setting or on behalf of such organization, company or government agency.


This web site contains links to other sites. Please be aware that we are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of each and every web site that collects Personal Information. This privacy statement applies solely to information collected by this web site.

Requests and Contact

Please contact us about this Privacy Notice or if you have any requests or questions relating to the privacy of your personal information.

Changes to this Privacy Notice

We may revise this Privacy Notice through an updated posting. We will identify the effective date of the revision in the posting. Often, updates are made to provide greater clarity or to comply with changes in regulatory requirements. If the updates involve material changes to the collection, protection, use or disclosure of Personal Information, Pearson will provide notice of the change through a conspicuous notice on this site or other appropriate way. Continued use of the site after the effective date of a posted revision evidences acceptance. Please contact us if you have questions or concerns about the Privacy Notice or any objection to any revisions.

Last Update: November 17, 2020