An option is an agreement with someone that gives you the right, but not the obligation to buy or sell something at a specific price on or before a specific date in the future. That’s all it is, period.

Let’s imagine you just got a job transfer to a new city, and you want to buy a house, but you want to wait until you know that it’s in an area that you and your family really like and that the new job works out before you buy a house. Part of your employment contract is that they rent you an apartment for a year and then at the end of the year the company will help buy you a home. The catch is that they will not spend more than $500,000 on a home for you, so that’s your ceiling for home prices.

You start looking at homes that are for sale just to get a feel for the local market and you find what you think would be the perfect house but don’t want to buy it for a year.

The house is on the market for $500,000 but since the property has been going up in value lately, you think that in a year the house might be worth $600,000 and if you could be guaranteed to be able to buy the house for $500,000 anytime in the next twelve months, that would be great.

So being a financial wizard, you offer the seller an option to buy the house for $500,000 ($500,000 is the strike price of this option.) The seller is not familiar with options, so you have to explain to him that you are not sure that you would like to buy the house, but you would like to have the option to buy it anytime in the next twelve months for $500,000. And for giving you this option, you will give him $25,000 in cash right now to buy this option (this $25,000 is called the option premium.)

You explain to him that at the end of 12 months if you don’t buy it (called exercising the option) he gets to keep the $25,000 you paid him and you will just walk away. (If you don’t “exercise” the option in the next 12 months then you are just letting the option expire.) But if you do agree to buy the house or “exercise the option” he must sell it to you for $500,00 even if the value shoots up to $600,000 or more. He accepts this offer and now you are “long” one house with a call option.

Now, what is your risk for doing this? That’s right, just $25,000, nothing more. If you decide to buy it you can, but if you decide you don’t want to buy it, you can just walk away and let the option expire. Either way, he gets to keep your $25,000.

Now keep in mind, the house at the end of 12 months would need to be worth $525,000 for you to break even ($500,000 to buy it plus the $25,000 that you paid in premiums to buy the option.) But you think it might be worth $600,000 at the end of the year, so it’s a good deal for you if it does go up that much.

Basic options concepts are pretty easy to grasp. Where the challenge comes in is knowing which options to buy or sell and how to know if the price you buy or sell it for is fair. You don’t want to pay too much for your options and you don’t want to sell options for less than they are really worth.

In this course, I am going to cover a whole lot of material and by the time you finish it I think you will have a very good understanding of why options are one of the most fascinating and potentially lucrative tools you will ever use.