If you are like most people, you have heard of options but don't know exactly what they are. Of course, this being a personal finance blog most of the readers are a bit more savvy, however I will start out this multi part series on Options with a brief introduction for those who may not know.

In the simplest term, options are a right to either buy or sell a stock at a given price up until a certain date. Each option is a contract, and that contract gives the option owner the right to buy/sell 100 shares of stock.

One option contract = 100 shares of stock

A call option is the right to buy stock at a given price, whereas a put option is the right to sell at a given price. The given price is called the strike price.

So if I bought 10 call options of Google (GOOG) at a strike price of $300, I would have the right to buy 1000 shares (10 contracts * 100 shares per contract) of Google stock at $300/share at any time until the option expires.

The options expires on the third Friday of the month. So if I bought a July 2005 option on Google, it would expire on July 15th (the third Friday).

That was a lot to digest, and a lot of termonology, so let's review:

Call Option - The right to buy 100 shares of the underlying stock at the strike price up until expiration.

Put Option - The right to sell 100 shares of the underlying stock at the strike price up until expiration.

Strike Price - The price that you can buy or sell the shares for.

Expiration - The third Friday of the month for which the option was issued.

You pay a premium for options, and once an option expires worthless you don't get the premium back. For example:

Google is at $288 this morning. I can buy a July 2005 call option on Google with the strike price of $290 for $16.25 per option. Remember that each contract gives me the right to buy 100 shares of stock at $290, so the total cost of each contract is $1,625 ($16.25 * 100 options). So let's say I bought ten contracts for $16,250. I now have the right to buy 1000 shares of Google stock for $290 at any time until July 15th (the third friday in the month in which they expire). If Google stock takes off and goes up to $390, I can make a $100 per share profit by buying for $290 and selling for $390. At 1,000 shares that would be $83,750 ($100,000 minus the premium cost $16,250) profit in a little over 6 weeks.

However, if Google tanks and goes town to $250, I would never exercise the options. Why would I pay $290 for a stock when I can get it on the open market for $250? Options give you the right to buy a stock at the strike price, you are not obligated to buy though. So if the stock price doesn't go above the strike price before expiration, the option expires worthless and I lose my entire investment, in this case $16,250.

So as you can see, it's very easy to both make money and lose money in options trading. If you predict the market correctly, you can make a lot of money, in my example I made $83,750 with a $16,250 investment in just over 6 weeks, over 400% return. Not a bad return. However, you stand to lose your entire investment if you're wrong, in this case $16,250.

Now, of course no one is expecting Google to jump 102 dollars in the next 6 weeks. But it isn't unheard of for stocks to gain 33% in that time period. Google is also a very volatile stock, which effects options pricing. If you chose a stock with less volatility the options pricing would be cheaper the further the strike gets away from the current stock price.

Stay tuned for future blogs in this series, where I'll explain the differences in option trading strategies and stock trading, and also fill you in on some conservative option plays.mortgage calculator