Options trading can be an exciting and profitable part of your investment portfolio. Before you start trading options, however, there are a few principles and characteristics of stock options that you will want to understand.

Stock options are investment instruments known as derivative securities. What does that mean? It simply refers to the fact that each stock option derives its value from an actual stock. Each option has an underlying security, so a stock option's value is directly dependent on the price movement of that underlying security. For example, the value of a single ABC Corp. option is derived from 100 shares of ABC Corp. stock.

Having established that stock options all have an underlying security, the next point to understand is this: A stock option is a contract which represents the right to buy or sell shares of the underlying stock. Each contract generally represents 100 shares of the underlying stock, and there are no partial contracts. Options traders can own as few as one contract and as many contracts as their options-trading capital will allow.

Buying a stock option contract does not obligate you to purchase or sell the actual shares of the underlying stock. It only signifies that you have the right (or option) to buy or sell.

A call option is a contract that gives its holder the right to purchase shares of the underlying stock. Purchasing a single ABC Corp. call option gives an option trader the right, but not the obligation, to buy 100 shares of ABC Corp. stock at a predetermined price during a specified period of time.

A put option is a contract that gives its holder the right to sell shares of the underlying stock. It is not necessary for a stock option trader to own shares of a particular stock in order to buy a put option. If an option trader purchases a single XYZ Inc. put, he or she has the right – but not the obligation – to sell 100 shares of XYZ Inc. stock for a particular window of time and at a certain price.

In many cases, option holders choose not to take any action to buy or sell the underlying shares of their option contracts. Instead, investors frequently decide to resell their call and put options.

All stock options have expiration dates. Expiration occurs for stock options on the third Friday of every month and each stock option is assigned an expiration month.

A stock option receives an expiration date upon its introduction to the market. Only during the time period from introduction through expiration may the stock option be bought, held, sold, or exercised.

For example, if you purchase a General Electric June call, GE must make the price move that you anticipated prior to expiration so that you can either resell or exercise the option for a profit on or before the third Friday in June. If, however, the GE shares do not move as you expected, you can sell your option at any time before expiration to cut your losses.

The final element that's critical to your basic options education is the concept of strike price. The strike price is the price at which the underlying stock will be bought or sold if you choose to exercise the stock option. Every option contract has a fixed strike price.

For example, if you purchase an ABC Corp. May 35 call, the strike price is 35. If the price of ABC Corp. – your option's underlying security – reaches 35 on or before the third Friday in May, you may choose to exercise your option and buy 100 shares of ABC Corp. for $35 per share. Or, if you choose not to exercise, you may sell your option as long as you do so on or prior to its date of expiration.

Option symbols are simpler than ever, thanks to some major changes that were instituted in February of 2010. Prior to that time, option codes were an arcane and often confusing collection of four or five letters that may or may not have included portions of the stock's ticker symbol. Today it is far more intuitive and easier to understand. For example, under the old current Options Price Reporting Authority (OPRA) codes, the symbol for Apple Inc.'s (AAPL) December 250 put was AJL XE – completely obscure to the average option trader. However, in the aftermath of the conversion, the symbol for the same option would look like this: AAPL 09 12 18 P 00250 000 – much more detailed and less cryptic. Here is how to read that symbol:

It's important to note that brokers are treating the new option codes as advisory rather than mandatory. While all are including the four required elements -- the root symbol, the specific strike, the expiration date, and the type of option (put or call) -- they are sequencing these elements according to their own preference. For example, Charles Schwab will render the Apple April 2010 250 put as AAPL 04 17 2010 250 P (ticker, expiration month, expiration day, expiration year in four digits, strike price, call/put indicator). Meanwhile, Fidelity will call that same option AAPL 10 04 17 P 250, while OptionsXpress will use AAPL April 10 250 Put. Check with your own broker before making a trade.

Most options are American-style, but some investors also trade European-style options.

An American contract may be exercised at any time before its expiration date. Most options, including equity options, are American-style.

A European contract is exercisable only on the expiration date, known as the settlement date. Options on the Standard & Poor's 500 Index are examples of European-style options.

However, owners of  European-style options may still buy or sell to close these positions at any time.

For a full list of index options that have European-style expirations, please visit the Options Industry Council

Why Trade Options?	Beginning Options Strategies	Advanced Options Strategies	So You Want to Trade Options	Expectational Analysis