An Option Contract is a special type of derivative which gives its owner (buyer) the right, not the obligation, to exercise a transaction on an underlying asset or security at a predefined future date and at a predefined price. Option gives its buyer the right to take the decision whether he will exercise the transaction or not. The seller of the Option has the obligation to perform the transaction if the buyer chooses to do so. To gain the right of taking the decision, buyer has to pay a premium, which stays with the seller if the buyer chooses not to use the right.
For every Option buyer there has to be an option seller, who has the obligation to do the transaction whenever the buyer exercise the option. For exchange traded options the clearing house acts as a mediator to facilitate all the options trading processes.
The main advantage of option is that it restricts the loss for the buyer. The maximum loss is limited to the premium paid by the buyer, but for the seller the maximum loss can be very high.