This are the type of derivative contract whose value is derived from another asset that is called underlying asset. There are two types of option contract are there that is
Call Option : That gives you a right to buy an asset
Put Option : That gives you a right to sell an asset.
The main purpose of option trading is to reduce risk or future price uncertainty through the strategy of of hedging , arbitraging and speculation, like just take an example that there is property whose current market price (CMP) INR 1 lac. you want to invest in that property but also have fear that what if the prices goes to below 1 lac that would your loss.
In that case you can make contract with seller that on a fixed future date or before that you will purchase this property at INR 1 lac /- for which today paying a INR 10k/- as contract price or premium amount.
In case when prices of property goes to above 1 lac, suppose after 1 month CMP of property is 1.5 lac here you have right to purchase the property at 1 lac . if you exercise the contract buy paying INR 1 lac to seller and in spot market you can sell this property at 1.5 lac.
2nd case when the prices of property (CMP) goes down up to INR 50,000/- and you have make contract to purchase the property at INR 1 lac. that would be your loss when you exercise this contract. and if you didn’t exercise this contract the maximum loss you may receive would be just INR 10k/- that amount that you have paid as contract price or premium.
it is clear from the above example if the prices of underlying asset (property) increase the premium or contract price also would increase in call option ( right to buy) and underlying asset prices decreases the premium or contract price would increase in put option (right to sell).