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Quote of the Day

We are all robots when uncritically involved with our technologies.

Marshall McLuhan

Option

An option is a contract whereby one party (the holder or buyer) has the right but not the obligation to exercise a feature of the contract (the option) on or before a future date (the exercise date or expiry). The other party (the writer or seller) has the obligation to honor the specified feature of the contract. Since the option gives the buyer a right and the seller an obligation, the buyer has received something of value. The amount the buyer pays the seller for the option is called the option premium.

Options are considered as a type of derivative which gives the holder of the option the right but not the obligation to purchase (a "call option") or sell (a "put option") a specified amount of a security within a specified time span. One can combine options and other derivatives in a process known as financial engineering to control the risk in a given transaction. The risk taken on can be anywhere from zero to infinite, depending on the combination of derivative features used. By using options, one party transfers (buys or sells) risk to or from another. When using options for insurance or hedging, the option holder reduces the risk he bears by paying the option seller a premium to assume it. Because one can use options to assume risk, one can purchase options to create leverage. The payoff to purchasing an option can be much greater than by purchasing the underlying instrument directly.

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