Equity options definition

Equity options are a form of derivative used exclusively to trade shares as the underlying asset.

In essence, equity options work in an extremely similar way to other options, such as forex or commodities. They offer the trader the right, but not the obligation, to purchase (or sell) a set amount of shares at a certain level (referred to as the ‘strike price’) before it expires. To buy an option, traders will pay a premium.

Equity option example

Let’s say that Google shares are trading at $450. You buy an option to purchase shares of Google before the end of the week at $500, and pay a premium of $25 to do so. If Google’s share value exceeds $525, then the trade is in profit, and you are free to execute the trade.