What is a stock option?

An option is a contract that gives a buyer the right, but not the obligation, to purchase shares of a stock at a predetermined price on or before a certain date. An option is a security, just like a stock or a bond, and these contracts may be traded just like other securities. For example, if Microsoft (MSFT) is at $50 on October 1st, the price of the option to purchase a share of MSFT for $50 at anytime before October 15th might cost me $2. If MSFT is still at $50 on October 15, I will lose my $2. However, if MSFT is at $60 on October 15th, I can still purchase the shares at $50, and therefore make a 10-2 = $8 profit, a good profit since I only put $2 at risk. Further, if MSFT goes down to $40, or lower, I still only lose the $2 I spent for the option. If I had simply bought shares of MSFT, I would have been down $10, or more. If used correctly, stock options can provide an effective alternative to traditional stocks.