A Random Walk Down Wall Street

by Burton G. Malkiel

A stock option, just as the name implies, gives the buyer the right (but not the obligation) to buy or sell a common stock (or group of stocks) at a specific price on or before a set date. For example, a call option on IBM might cost the buyer $15 a share (the option premium) expiring the third Friday in July (the expiration date) with an exercise price of $150 a share (the striking price). Thus, for a premium of $15, the buyer of this call option has the right to purchase a share of IBM at $150 at any time up through the third Friday in July. The seller (or writer) of the option receives the premium and takes on the corresponding potential obligation to sell the share at the contract price. A put option reverses the situation. A put on IBM gives the holder the right to sell IBM shares at a specific price. The seller of the put (called the writer) takes on the potential obligation to buy the shares.