An option gives the buyer the right but not the obligation to buy the underlying asset at an agreed price (strike price), on or before an agreed date (expiration date) in the future. For this right the buyer of the option pays a cost (premium).
The buyer of an option can purchase a call option (buy the underlying asset) or a put option (sell the underlying asset). The ‘holder’ of a call option is hoping that the underlying asset will increase in price so that he can sell his option for a profit at expiration. If the underlying asset does not rise above the strike price the holder can simply let the option expire and the maximum loss will be the premium he paid. Buyers of calls are bullish on the asset, while buyers of put options are bearish on the asset. A buyer of a put option would be expecting the price of the underlying asset to decline. If it does then the holder can buy back the underlying asset at a profit.
The option holder’s only risk is the cost of the premium which he pays to the option writer.
The seller (writer) of an option can sell either a call option or a put forex option. Unlike the buyer (holder) of the option the seller of the option is obliged to uphold his side of the contract. As the writer of an option cannot be sure if the option holder will exercise the option or not the writer receives a premium from the option holder for the risk he is taking. If the option holder decides to let the option expire the premium the option writer receives is his profit. If the option holder chooses to exercise the option then the option writers’ losses could be very high especially if the price of the underlying asset has moved a long way from the strike price.
If at expiration date the underlying asset’s price on a call option is above the strike price the option is said to be in-the-money for the option holder. If at expiration date the underlying asset’s price was the same as the strike price including the premium cost, the option is said to be at-the-money. If at expiration date the underlying asset price is lower than the strike price then the option is said to be out-of-the-money.
A put option holder would like to see the underlying asset’s price lower than the strike price for it to be in-the-money and higher for it to be out-of-the-money.
The above is the basic lingo used in options trading.