All investors know that buying stock entitles them to partial ownership in the corporate entity issuing those shares. In other words, you are purchasing an "equity" participation in the company. Most stocks listed and traded on U.S. stock exchanges are termed equity securities. What is an option, then? In a word, an option is actually a contract. Unlike stock, however, an option does not convey to the purchaser ownership in anything. Instead, an option contract conveys a right to its owner to buy or sell the underlying financial instrument on which it is based. The options we will be talking about in this class are based on equity securities, or stocks, and are thus referred to as "equity options." There are "regular" options that have expiration dates up to 9 months from the day they are issued, and there are long-term options that have expirations of up to three years called LEAPS®. When either of these types of equity options is exercised, a physical delivery of shares of its underlying stock from one party to another takes place. We'll see how this works a little later.
Let's define the option contract a little further. Equity options, like stock, are classified as securities. More specifically, though, equity options are termed "derivative securities". This term implies that their value is in part based on, or derived from, the value of their particular underlying stocks. As securities, they are available for trading on any of the exchanges in this country that list equity options. Just as the stock market, the Securities and Exchange Commission (SEC) oversees trading of all exchange-listed equity options in the U.S. marketplace.