Option

The right to buy or sell a specific security (such as a stock) for a preset price during a specified period of time. Options differ from futures in that with an option, you pay a premium fee upfront and you can either exercise the option or let it expire. If the option expires worthless, you lose 100 percent of your original investment. The use of options is best left to companies as hedging tools. Investment managers may use options to reduce the risk in their investment portfolio. As with futures, when most individual investors buy an option, they’re doing so as a short-term gamble, not as an investment. For example: You have an option to buy 100 shares of Rocky and Bullwinkle Co. stock at $20 per share in the next six months. You pay $3 per share upfront as the premium. During this time period, R&B’s share price rises to $30, and you exercise your right to buy at $20. You then sell your shares at the market price of $30; you make a $10 profit per share, which is a return more than three times larger than your original investment.