What they Are Options are not securities themselves, but are contracts that let you to buy or sell a security like a stock at a set price between now and a certain future date. Options give you the ability to hedge investment risks or to earn magnified gains through what's known as leverage.
How they Work There are two types of options. Call options give you the right to buy a certain security at a set price between now and a future date. Put options give you the right to sell a certain security at a set price on or before a future date. There are many ways in which you can use options to your benefit. However, most fit into either pessimistic (bearish) or optimistic (bullish) strategies. A common bearish strategy is called a covered put. You use this when you want to sell a stock in a few months from now but think the share price is going to drop and you'll lose money on the sale. If the stock has an option listed on it, you can buy a put option usually for a few dollars per share that gives you the right to sell your stock any time in the next few months at a price that's attractive to you. If the price of your stock falls, you can exercise your put option and sell your shares at a higher price than they're worth on the open market. If your shares stay the same price or go up in value, you can just walk away from the put option. All you'll lose is the price you paid for the put. A common bullish strategy is to buy a call on a stock you think is going to rise in value in the next short while. Instead of buying the stock itself, you can buy a call option if you think the price is going to rise. If EFG stock is trading at $35, you might buy a call option that gives you the right to buy 100 shares of EFG stock for $40 in the next three months. The option contract might cost $1 per share or $100 for the 100 shares while if you bought the shares you'd have to pay $3,500.
The Risks Options are both complex and risky for the novice investor. You could lose 100% of your investment.
The Rewards Used properly, options can reduce your risk. They can also let you participate in a stock for a relatively small amount of money and realize magnified potential gains.