An options contract is an agreement between a buyer and a seller that gives the buyer the right, but not the obligation, to buy or sell a specific asset at a specific strike price on or before a specific expiration date.
Options that expire in-the-money are settled through exercise and assignment. Exercise and assignment are two sides of the same transaction. An option buyer has the right to exercise an options contract. An options seller is obligated to accept assignment from an exercised options contract.
Options are leveraged financial instruments that derive their value from an underlying security. The underlying in an options contract is the security or asset from which the option derives its value.
Every option contract has an associated premium, or cost. A contract has three main components that determine the premium:
- Underlying Security’s Price
- Strike Price
- Expiration Date
The contract's strike price relative to the underlying security's price is the intrinsic value. Time remaining until expiration and volatility are the main factors of an option's extrinsic value.
The Options Handbook discusses options basics, options pricing, settlement, and exercise and assignment.