Options are purchasing the "option" to buy or sell a security if it reaches a goal price at a certain time. For example, say I want to buy (and this would never happen, it's just easier to think about when you aren't talking securities and are talking objects we buy daily) tomatoes. I want 40 tomatoes, but not at $1.50 each. I want them in 30 days, so if in 30 days, those tomatoes go below $1.20 each, I will buy 40 tomatoes. If not, well then I don't have to buy. I only purchased an option to buy those. If the price goes up or not down far enough, I can walk away and only pay for the option and not the 40 tomatoes.
This works for selling too. Options are like buying insurance. They are good to have in a bad (or rare) situation, but not that great to have in a normal market situation. It is like predicting what will happen.
This is the biggest reason why someone would want to buy or sell an option. Say I want to purchase a straddle. I am predicting that this stock will move a lot, however I'm not sure if the price will go up a lot or down a lot. So I basically buy 2 options (a call and a put) so that there is the strike price of $50 (that is the price I'll buy the stock at, no matter how it moves). I will then place my call and put around that, so a buy will happen if the stock goes way up, and the sell happens if the stock goes way down. Now if a large jump happens, I can now go back and say to myself "Looky there....I have an option to buy at this low price of $50 and now the stock is up to $90!" and therefore I make a profit. However, I'm also paying A Lot to have an option, so that comes out of my earnings.
Now if the stock price doesn't move at all, then I am stuck paying for that expensive option and I never got to use it. It is a way to make money, or to hedge (protect) yourself against a problem. It however, costs a lot to do.
Businesses might use the "hedge" option (like the straddle I mentioned earlier) if they are going to be buying or selling a lot from a foreign country and are worried that the exchange rate will become more expensive for them. We personally wouldn't want to do that; however, a company who buys and sells millions of dollars worth of stuff, would want this protection.
Investors have the ability to hedge against foreign currency risk by purchasing a currency option put or call. For example, assume that an investor believes that the USD/EUR rate is going to increase from 0.60 to 0.95 (meaning that it will become more expensive for a European investor to buy U.S dollars). In this case, the investor would want to buy a call option on USD/EUR so that he or she could stand to gain from an increase in the exchange rate.
This works for selling too. Options are like buying insurance. They are good to have in a bad (or rare) situation, but not that great to have in a normal market situation. It is like predicting what will happen.
This is the biggest reason why someone would want to buy or sell an option. Say I want to purchase a straddle. I am predicting that this stock will move a lot, however I'm not sure if the price will go up a lot or down a lot. So I basically buy 2 options (a call and a put) so that there is the strike price of $50 (that is the price I'll buy the stock at, no matter how it moves). I will then place my call and put around that, so a buy will happen if the stock goes way up, and the sell happens if the stock goes way down. Now if a large jump happens, I can now go back and say to myself "Looky there....I have an option to buy at this low price of $50 and now the stock is up to $90!" and therefore I make a profit. However, I'm also paying A Lot to have an option, so that comes out of my earnings.
Now if the stock price doesn't move at all, then I am stuck paying for that expensive option and I never got to use it. It is a way to make money, or to hedge (protect) yourself against a problem. It however, costs a lot to do.
Businesses might use the "hedge" option (like the straddle I mentioned earlier) if they are going to be buying or selling a lot from a foreign country and are worried that the exchange rate will become more expensive for them. We personally wouldn't want to do that; however, a company who buys and sells millions of dollars worth of stuff, would want this protection.
Investors have the ability to hedge against foreign currency risk by purchasing a currency option put or call. For example, assume that an investor believes that the USD/EUR rate is going to increase from 0.60 to 0.95 (meaning that it will become more expensive for a European investor to buy U.S dollars). In this case, the investor would want to buy a call option on USD/EUR so that he or she could stand to gain from an increase in the exchange rate.
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