What is an option?

An option gives the buyer the right, but no obligation, to buy or sell a stated quantity of a commodity (some “asset”) at a specified price on or before a specific date in the future.

Options are often compared to insurance. When you buy homeowner's insurance, for example, you pay a premium for certain rights. These rights are yours, but the policy can limit the payoff. To some extent, this analogy works for a hedger, but there are major differences when speculating. For example, the option buyer theoretically has unlimited profit potential. Insurance policies have a stated limit. Insurance is not transferable between parties and is usually specific to a person or property. Options are standardized and in most cases can be ...

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