A privilege, for which a person has paid money, that grants that person the right to purchase or sell certain commodities or certain specified SECURITIES at any time within an agreed period for a fixed price.
A right, which operates as a continuing offer, given in exchange for consideration—something of value—to purchase or lease property at an agreed price and terms within a specified time.
An option is a type of contract that is used in the stock and commodity markets, in the leasing and sale of real estate, and in other areas where one party wants to acquire the legal right to buy something from or sell something to another party within a fixed period of time.
In the stock and commodity markets, options come in two primary forms, known as "calls" and "puts." A call gives the holder of the option the choice of buying or not buying stock or a commodities futures contract at a fixed price for a fixed period of time. A put gives the holder the option of selling or not selling stock or a commodities futures contract at a fixed price for a fixed period of time. Because an option only has value for a fixed period of time, its value decreases with the passage of time. Because of this feature, it is considered a "wasting" asset.
There are four parts to an option: the underlying security, the type of option (put or call), the strike price, and the expiration date. Take, for example, an "International Widget July 100 call." International Widget stock is the underlying security, July is the expiration month of the option, $100 is the strike price (sometimes referred to as the exercise price), and the option is a call, giving the holder of the call the right, not the obligation, to buy one hundred shares of International Widget at a price of $100. The holder of the call cannot buy the one hundred shares until the exercise date.
In the case of a commodity option, the right to purchase or sell pertains to an underlying physical commodity, such as a specific quantity of silver, or to a commodity futures contract. The period during which an option can be exercised is specified in the contract.
Stock option plans are used in business to reward employees. A stock option is a contract between the company and the employee giving the employee the right to purchase shares of company stock between certain dates at a price that is often fixed by the company or determinable by formula at the time the option is granted. For example, International Widget may issue an option to a key employee, which will allow the employee to purchase one hundred shares of stock at the fair market value at the grant date. The employee has five years in which to exercise that option. If the price increases above the grant-date fair market value, the employee will presumably exercise the option and realize an economic gain based on the spread between the fair market value at the grant date and the fair market value at the exercise date. If the price decreases after the option is granted, the employee will forgo exercising the option and thereby have no loss in economic value.
Options have a role in business outside the stock and commodity markets. In the law of contract, the option is a continuing offer to purchase or lease property. The offer is irrevocable for the stated period of time. Like most other contracts, the option contract is not terminated by the sub-sequent death or insanity of either party.
Options usually assume one of two forms. The seller can state to the purchaser, "If you pay me $500 today, I promise to sell Whiteacre to you for $50,000 on the condition that you pay the $50,000 within sixty days." If the purchaser pays the $500, a unilateral contract—an agreement in which there is a promise on only one side and a possibility of a performance by the other side—is created, and the offer is irrevocable. The seller of Whiteacre is obligated to perform if the purchaser pays the $50,000 within sixty days.
The second form of option contract is created when the seller states to the purchaser, "I offer to sell you Whiteacre for $50,000. This offer will remain open for sixty days if you pay $500 for this privilege." If the purchaser pays the $500, there is a collateral contract—an agreement made prior to, or simultaneous with, another agreement not to revoke the offer—and the seller is obligated not to revoke.
Acceptance of an option contract is operative when received by the offeror, rather than when sent. An option contract is interpreted strictly in favor of its creator and must be unequivocal and in accordance with the terms of the option. It is frequently said that "time is of the essence" in an option contract, but this means only that the option cannot be exercised after the offer has lapsed.
An offer can be accepted only by the person or persons for whom it is intended. Therefore, no assignment—a transfer to another of any property—of an offer can be made. The prohibition is based on the concept that everyone has the privilege of choosing with whom to contract. Once an offer has ripened into a contract, however, the rights thereby created are usually assignable. For example, if Jane offers an option to Jack to purchase Whiteacre, Jack cannot accept the option and then assign it to Joe. Once Jack and Jane enter into a contract for the sale of Whiteacre, Jack can assign his contract rights to Joe.