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contracts or just let them expire, but they also face a high risk of losing their entire investment. More on this later.

So what are the underlying products for options? There are several, but futures and stocks are the most popular. A futures option is like a derivative on a derivative. The buyer (depending on the type of the option - call or put) has the right to buy or sell the underlying futures contracts at the specified price. As you can imagine, dealing with futures options is tricky. You are dealing with a two-fold derivative on commodities and financials, which can get pretty complex. I don't mean to scare you off, but futures options take some getting used to, and in my opinion they are unsuitable for the average investor. Therefore I will continue the rest of this chapter with the coverage of stock options (a.k.a. equity options) and some stock index options. A lot of the information that we will cover also applies to futures options, and you can use it as a basis should you want to pursue futures options further.

A stock option is the right to buy or sell a specified number of underlying shares at a fixed price per share prior to the expiration date. In other words, by exercising stock options the buyer, depending on the option type (call or put), gets to buy or sell a specified number of shares of the underlying stock at the specified price. The buyer also has the option (no pun) of not exercising the options at all, letting them evaporate at expiration date.

Since we are talking contracts you may wonder how many shares are represented. Option contracts generally represent 100 shares of their underlying stocks. Exceptions are when there are stock splits or mergers. Options are always expressed and traded in whole contract units (no partial contracts). So for example, when you buy 4 contracts of a certain option, you are actually buying options on 400 shares of the …