Options: the basics

In finance, options are securities that convey the right, but not the obligation, to engage in a future transaction on some underlying security. For example, a call option provides the right to buy some amount of a security at a set strike price at some time on or before expiration, while a put option provides the right to sell. Upon the option holder's choice to exercise the option, the party that sold, or wrote, the option must fulfill the terms of the contract.[1]

The theoretical value of an option can be determined by a variety of techniques, including the use of sophisticated option valuation models. These models can also predict how the value of the option will change in the face of changing conditions. Hence, the risks associated with trading and owning options can be understood and managed with some degree of precision.

One important class of options are called exchange-traded options and have standardized contract features and trade on public securities exchanges in order to facilitate open trading among independent parties. Other options are traded between private parties, often well-capitalized institutions, that have negotiated separate trading and clearing arrangements with each other. Still another important class of options, particularly in the U.S., are employee stock options, which are awarded by a company to their employees as a form of incentive compensation. However, many of the valuation and risk management principles apply across all financial options.

via: http://en.wikipedia.org/wiki/Option_%28finance%29