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Need help with an Options Contract?
What Is an Options Contract?
An options contract is an agreement between two parties used to facilitate a possible transaction. This type of contract is for the right to buy or sell an underlying asset, such as stock, at a price that is set at the time of the contract. This is called the strike price. The transaction can take place up until the contract's expiration date.
Common types of assets an options contract may cover include:
- Real estate
Possibly the most important aspect of an options contract is that while it gives someone the right to buy or sell an asset, the individual who purchases the option is not required to buy or sell.
There are two kinds of options contracts, called call and put options. You can buy options contracts to speculate on stocks, or you can sell these contracts to generate income.
Typical stock options contracts cover 100 shares of an underlying stock, although this amount can be adjusted for:
- Special dividends
- Stock splits
How Does an Options Contract Work?
An options contract includes terms that specify:
- The contract's expiration date
- The strike price, or the price at which an underlying asset may be transacted
- The underlying asset
You can generally purchase call options as a leveraged bet on a stock or index's appreciation. You generally purchase put options, on the other hand, to make a profit when prices decline.
Call option buyers have the right but are not required to buy the amount of shares that the contract covers at the set strike price. The opposite is also true: Put buyers have the right but are not required to sell their shares at the strike price a contract sets.
However, option sellers must transact their side of any trade if the buyer chooses to either execute the call option and purchase the underlying asset or execute the put option to sell the underlying asset.
Traders typically use options for hedging. However, options can also be used for speculation. This is because options usually cost just a part of what the underlying securities themselves would cost. You can use options as a way of getting leverage, as they allow an investor to bet on a stock without needing to buy or sell those shares outright.
What Is a Put Option?
You would typically purchase a put option when you expect to profit from the price of an asset declining. Buyers of a put option own a right to sell their shares at the strike price listed in the contract.
If each share's price drops below the strike price the contract lists before the expiration of the contract, the buyer can assign shares to the seller of the contract to purchase at the strike price. The buyer also has the option to sell their contract if the shares aren't held in the portfolio.
What Is a Call Option?
You would typically buy a call option to leverage the price of an asset such as a stock, index, or other asset. You can buy a set amount of shares at the strike price. The contract should specify both the number of shares (or other assets) you purchase as well as the strike price.
When a call option transaction occurs, the position opens when the buyer purchases a contract from the seller. The seller is also called a writer in these transactions. The seller of a call option receives a premium when they assume the obligation to sell their shares at the strike price. The buyer benefits by getting the option to purchase the asset at the strike price, no matter if the value of the asset increases above that price in the period of time covered by the contract.
Here is an article with more information about put and call options.
Why Do People Choose Options Contracts?
Options contracts have a few different advantages. These benefits include:
- The seller receives a premium: The seller of an options contract receives a payment (the premium). They get that premium regardless of what happens with the contract after that point. That's why you'll find options traders who use received premiums as a big amount of their portfolio income.
- The buyer can lock in their right, without paying a lot: The buyer of the option also benefits. They can lock in their right to acquire the asset involved in the contract while only putting up a small amount of their money upfront. Since options contracts usually cost just a part of what the stock or other asset would cost — and the strike price is only due if the owner of the option decides to exercise their contract — the contract owner can gain the right to buy the asset at an attractive price.
- Options contracts give investors flexibility: If an investor uses options contracts well, it gives them the flexibility to take action with their portfolio and can help control risk while maximizing returns.
Image via Unsplash by austindistel
Common Areas Where Options Contracts Are Used
You will most frequently see option contracts in the financial industry. Options contracts are also commonly found in real estate.
Options Contracts in Financial Industry
You can option the chance to buy or sell stock at a certain price for a specified period of time. Again, the buyer of the option is not obligated to exercise their option.
Options Contracts in Real Estate
It is also fairly common to use options in real estate transactions. This is because a potential buyer of a property often needs additional time to complete steps such as securing funding and inspecting the property before they make an actual purchase. A seller and potential buyer can therefore agree on a certain selling amount while the buyer completes any necessary steps. Once the buyer agrees to terms within that set time period, the parties can create a binding contract for the transaction.
Here is an article with further reading about real estate options.
Options Contracts as Part of an Employment Offer
Many companies, especially startup companies and small businesses, offer options contracts as part of their benefits package. Employee options contracts offer employees the option to purchase stock in their company at a very reduced price.
This arrangement has benefits for both the employer and employee. Both the business and the employee hope the company stock will rise in price, giving the employee incentive to work hard to make that happen.
What Is Included in an Options Contract?
Options contracts contain the elements of a typical contract, including:
- The offer made by a promisor
- The acceptance of a promisee
- Consideration (this is the exchange of something of value for something else of value)
- Mutuality of parties
- Legal capacity for parties to enter into the contract
- Legally acceptable terms
An options contract will typically include the following additional elements:
- The underlying security
- The type of option (whether it is a call option or a put option)
- The commodity involved in the contract
- The date on which the contract is enforced
- The strike price
- The expiration date
You may want to use an options contract to purchase stock options or real estate, or you may wish to offer stock options to employees. It's important to work with an experienced lawyer when creating these contracts.
Meet some of our Options Contract Lawyers
I have been practicing law for 35 years. In addition to my law degree, I hold an MBA. I've created six companies, currently act as outside counsel to another 12, and have been an advisor to more than 500 startups and entrepreneurs.
I am a licensed and active Business Attorney, with over 20 years of diverse legal and business experience. I specialize in contract review, drafting, negotiations, ecommerce business transactions, breach of contract issues, contract dispute and arbitration. I am licensed to practice in New York and Connecticut. I am a FINRA and NCDS Arbitrator. My experience includes serving as General Counsel to small businesses. I negotiate, draft and review a wide array of commercial contracts; provide business strategy and employment advice and assist in the sale of businesses entities. I work extensively with various kinds of contracts. In reviewing agreements, I conduct risk analysis of contract and interpret the terms and conditions so that clients understand exactly what their obligations are under the agreement and are protected as much as the law requires. I am detailed and thorough in my review and drafting of agreements. Additionally, I advise clients on how to limit their liability and lower their contractual risk. I specialize in breach of contract issues and arbitration. I have been a Hearing Officer, presiding over cases and rendering written decisions; a Civil Court Arbitrator presiding over cases in contract law, commercial law, etc., a Judicial Clerk in Civil Court; a Vice President at an Investment Bank and an Attorney at top AML law firms.
Carlos Colón-Machargo is a fully bilingual (English-Spanish) attorney-at-law and Certified Public Accountant (CPA) with over twenty years of experience. His major areas of practice include labor and employment law; business law; corporate, contract and tax law; and estate planning. He is currently admitted to practice law in Georgia, Florida, the District of Columbia and Puerto Rico and currently licensed as a CPA in Florida. He received a Master of Laws from the Georgetown University Law Center in 1997, where he concentrated in Labor and Employment Law (LL. M. in Labor and Employment Law) and a Juris Doctor, cum laude, from the Inter American University.
Graduate of Georgetown Law (J.D. and LL.M in Taxation) Injury Claims Adjuster before law school for top insurer Eight plus years of legal experience Past roles: Associate at premier boutique law firm in the DC metro area Policy Associate at a large academic and research institution Solo Practice Areas of Expertise: Contracts Business Formation Trusts and Estates Demand Letters Entertainment Transactions
As a business law attorney serving Coral Springs, Parkland, and Broward County, FL, Matthew has been recognized as “AV” rated, which is the highest rating an attorney can achieve through Martindale’s Peer Review system. Year after year Matthew is listed in the “Legal Leaders” publication as a top-rated attorney in South Florida in the areas of litigation, commercial litigation, and real estate. Matthew is also a graduate and instructor of the Kaufman Foundation’s FastTrac NewVenture Program, presented by the Broward County Office of Economic and Small Business Development.
John Benemerito is the Founder and Managing Partner of Benemerito Attorneys at Law. Admitted to practice in New York and New Jersey, John represents small business owners and startups in the areas of Business and Securities Law. John received his Bachelors Degree at John Jay College of Criminal Justice where he majored in Criminal Justice. Afterwards, he attended New York Law School where he focused his studies on Corporate and Securities Law. John comes from a family of entrepreneurs. From as far back as he can remember he was always involved in his family’s numerous businesses. At the age of fifteen, John entered into a new business venture with his father and managed to grow and maintain that business through high school, college and law school.John is currently a co founder in over five different businesses. After law school, John decided that he wanted to help people like himself. He opened his own law practice and began working primarily with small business owners until he was introduced into the startup world. Ever since that time, John has worked with hundreds of startups and thousands of entrepreneurs from all different backgrounds in helping them achieve their goals. Having been an entrepreneur his entire life, John understands what it takes to create and maintain a successful business. He enjoys sitting down and working with his clients in figuring out each of their unique challenges.
California-based small business attorney handling matters related to securities, mergers & acquisitions, corporate governance, and other business transactions.