There are two types of equity option contracts: calls and puts. Call options give the buyer the right to purchase the underlying stock at a pre-determined price between now and a certain date. Put options give the owner the right to sell their stock at a pre-determined price between now and a certain date.

While these definitions are important to know, this course will not be focused around the ability to buy and sell the underlying stocks. We are going to teach you how to profit from the price fluctuations in the value of the option contracts. A better definition for our lessons is as follows:
Call options give the buyer the ability to profit from the upward movement of the underlying stock.
Put options give the buyer the ability to profit from the downward movement of the underlying stock.

The leverage provided by options allows us to do this while limiting our risk and capital requirements. We also have the ability to experience large percentage gains in the hundreds of percents.

One important note we want to discuss right away: equity options are nothing like the unregulated derivatives or credit default swaps used in the recent housing crisis. Unlike those types of contracts, ALL equity option contracts are regulated and cleared by the Options Clearing Corporation (OCC), which guarantees liquidity and fair settlement in the options market. For more information, visit www.optionsclearing.com. Be sure to read the Characteristics and Risks of Standardized Options as well, located at: http://www.optionsclearing.com/publications/risks/riskchap1.jsp. Equity options are just as safe as stocks and like stocks are also monitored by the Securities and Exchange Commission (SEC).

With that said, let’s use the rest of this lesson to memorize key terms that are associated with options. You’ll need to know the meanings of each to properly understand options:

Finally, it is important to understand how the options marketplace generally works. When you place an order to buy a certain option contract, that order is then sent to trading floor of one of many option exchanges. The OCC then matches your order with a counter party. For example, if you want to purchase a call option, the OCC will find a counter party who wants to sell a call option. The buyer (you) and seller (counter party) are then matched up and the standardized option contract is traded.  The same process takes place for put options.