Suppose that Kumquat did not sell any stock to Sam Jones. Instead, Kumquat sold Sam an option to buy Kumquat Common in 24 months at $13 per share, no matter how much the stock of the corporation had risen on the open market?

Sam has the right not the obligation to buy a share of Kumquat at $13 in 24 months irrespective of what the share will be on that date.

Explanation:

A stock option is an agreement between two parties that gives the option holder the right but not the obligation to buy or sell an underlying stock at a fixed price at a future date.

The parties in this question are Kumquat and Sam Jones (the option holder).

The item to be traded is called the underlying asset; the common stock of Kumquat in this case. Bond, stock, index, currency, interest rate are other examples of other underlying assets over which an option can be created.

The strike/exercise price: This is the fixed price agreed today at which underlying asset (stock) may be traded at a the future. It is $13 here. I

Option Premium: This is a one-off payment to be made by the buyer (Sam) to have the right to buy the stock. It is not given in this question. If the stock price at the 24th month is lower than the exercise price. Sam will allow the right to lapse - he wont exercise his right. Hence he losses his premium

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