• Options can mitigate the risk of stock investment or dramatically increase potential return.chart background image by Stasys Eidiejus from Fotolia.com
  
  A stock option is a financial instrument allowing the purchaser to acquire a given asset at a given price. Options can be purchased for various types of assets, stock being one of the most common. There are several characteristics of options it is important to understand in order to achieve a working knowledge of them.
  
  

Option Types

• The main types of options are call and put. The call option imbues the holder with the right, though not the obligation, to purchase the asset at a given price. The put option entitles the holder to sell the asset at a given price. The specified price for the asset is referred to as the strike price. All options have an expiration date, at which they expire if not exercised.
  
  

Write/Hold

• There are also two sides to the activity of options investment. One side is that of purchasing options; purchasers of options are called holders. The other side is that of issuing options; issuers of options are called writers. While holders of options are allowed to decide whether they wish to exercise the option (purchase or sell the asset at the strike price), writers are obligated to buy or sell the asset if the option holder does exercise it.
  
  

Speculation

• There are various techniques for making use of options. One such technique is to hedge a long position in a stock with a put. By doing this, if the stock decreases in value (causing a loss to the investor), as a holder of a put option, he is entitled to sell that security at the strike price. An investor may also purchase a call option on a security in hopes that it will appreciate in value. He need not actually purchase the security, as long as he has purchased the option. If the stock goes up in price, he can exercise the call, purchase the stock at a discount and then immediately sell it for a profit. In fact, speculators sometimes purchase a call option and a put option on the same security. In doing this, if the stock moves in price, they can exercise whichever option is profitable.
  
  

Risk

• Options are not without risk however. Whenever an option is exercised, the writer of that option will take a loss. If an option is not exercised, then it will expire worthless, the holder taking a loss in the form of commissions paid. When options are used for hedging, they reduce the overall risk exposure of the portfolio. However, by doing this they necessarily limit the upside potential for profit. Even purchasing calls and puts on the same security are not guarantee. If the security's price remains stable, both options expire worthless.