An option account is a special type of trading account with a brokerage firm. Almost any type of investment account, from an individual account to an individual retirement account (IRA), can have options privileges. There may be restrictions, however, on the type of options that can be traded in a given account.
Options trading is a specific form of investing limited to those investors with an option account. Instead of buying stocks, or shares in companies, an options trader purchases the option to buy stocks. This creates considerably more leverage with a person's money, since the option to buy a stock at a certain price generally costs much less than a share of stock would.
A person who buys an option does not have the obligation to buy the stock associated with the option. He simply has the right to do so. It becomes advantageous to purchase the stock if the market price rises above the price at which there is an option to buy.
For example, stock A may be selling at $10 US Dollars (USD) per share. An investor with an option account could buy an option to purchase stock A at $11.00 USD per share. If stock A then went to $11.01 USD per share, the investor would be able to either sell his option for more than he paid for it, or exercise his option and buy the stock at $11.01 USD.
Options trading is generally considered to be a risky investment. Options contracts have only a set period in which the investor is entitled to buy the stock based on the option. As a result, if the stock does not reach that price — called the strike price — during the period that the options contract is valid, the value of the option goes to $0.00 USD.
As a result of the risk associated with options trading, in the US, the Securities and Exchange Commission (SEC) stipulates that an option account can only be granted to investors by special request. An investor who wants to open an option account must fill out a form certifying that he understands the risk. The form also asks other questions, such as the investor's household income, the amount of liquid assets the investor has, and the investor's years of experience in stock trading.
In certain accounts, such as an IRA, options trading is limited to selling "covered calls." Covered calls means that the investor owns a stock and sells an option to buy that stock to someone else. Selling covered calls is the reverse of buying an option, and is generally considered less risky since the investor is merely limiting his upside on a stock he owns, instead of purchasing an option to buy.
