An option is a financial instrument that gives its holder the right, but not the obligation, to buy or sell something at a predefined price within a designated date range. If the holder chooses not to exercise the instrument by the end of the designated date range, it expires. The two types of options are:
- Call option. The holder has a right to buy something from the other party to the option.
- Put option. The holder has a right to sell something to the other party to the option.
The most common option arrangement is for a person to be awarded an option to buy the stock of his or her employer at a predetermined exercise price, which is usually the market price on the day when the option is awarded. If the market price of the employer's stock subsequently increases, the individual should exercise the option to buy shares, since he or she can then acquire the shares at the exercise price, rather than the current market price. If the market price instead stays flat or falls, the person cannot earn a profit and instead lets the option expire.