Stock Option
A stock option (also known as an equity option), gives an investor the right, but not the obligation, to buy or sell a stock at an agreed-upon price and date. There are two types of options: puts, which is a bet that a stock will fall, or calls, which is a bet that a stock will rise. Because it has shares of stock (or a stock index) as its underlying asset, stock options are a form of equity derivative and may be called equity options.Employee stock options (ESOs) are a type of equity compensation given by companies to some employees or executives that effectively amount to call options. These differ from listed equity options on stocks that trade in the market, as they are restricted to a particular corporation issuing them to their own employees.
Stock Options
Definition
Stock options (also known as equity options) give investors the right, but not the obligation, to buy or sell stocks at an agreed-upon price and date. There are two types of stock options: put options and call options. Put options are a bet that the stock will decrease in value, while call options are a bet that the stock will increase in value. Since stocks (or stock indices) are the underlying assets, stock options are a form of equity derivatives.
Origin
The concept of stock options can be traced back to the early 20th century, but the real market trading began with the establishment of the Chicago Board Options Exchange (CBOE) in 1973. The establishment of CBOE marked the entry of stock options as a standardized financial instrument into the public eye, gradually becoming an important tool for investors to manage risk and speculate.
Categories and Characteristics
Stock options are mainly divided into two categories: call options and put options.
- Call Options: The holder has the right to buy stocks at a specific price on a future date. Suitable for investors who expect the stock price to rise.
- Put Options: The holder has the right to sell stocks at a specific price on a future date. Suitable for investors who expect the stock price to fall.
Additionally, there are Employee Stock Options (ESOs), which are a form of equity compensation given by companies to some employees or executives, essentially call options. Unlike market-traded stock options, ESOs are issued by the company to its employees.
Specific Cases
Case 1: Suppose an investor buys a call option with a strike price of $50 and a premium of $5. If the stock price rises to $60 on the expiration date, the investor can buy the stock at $50 and sell it at the market price of $60, netting a profit of $5 after deducting the premium.
Case 2: A company grants its executives a certain number of employee stock options each year, with a strike price set at 90% of the current stock price. If the company's stock price rises significantly over the next few years, the executives can buy the stock at the lower strike price, thus gaining substantial profits.
Common Questions
Q1: What is the difference between stock options and stocks?
Stock options are the right to buy or sell stocks, while stocks are actual shares of company ownership.
Q2: Why use stock options?
Stock options can be used for hedging risk, speculating for profit, or as an employee incentive tool.
Q3: Are stock options risky?
Yes, stock options are high-risk, high-reward instruments, and investors may lose the entire premium paid for the options.
