• Options provide flexibility that may be unavailable otherwise.chart background image by Stasys Eidiejus from Fotolia.com
  
  Two concepts are important to note when discussing preferred stock options. The first is the nature of preferred stock itself. Preferred Stock is considered to be a hybrid instrument, a security containing features of debt and equity. The other concept important to note is that of an option. While securities have to follow certain rules, an option is just as it sounds, the right to obtain an asset at a prearranged price.
  
  

Preferred Stock

• Publicly traded companies are owned by shareholders. This ownership is distributed via common stock. Each shareholder possesses ownership and exerts control based on the proportion of common stock that she owns. These stocks often pay dividends, typically on a quarterly basis. However, these dividends are usually contingent upon the firm showing a profit over this period. If the firm takes a loss it may opt to reduce or even forego payment of dividends. Preferred Stock is called so because it commits the firm to payment of dividends even if it takes a loss. This payment may be constant or tied to certain statistics like interest rate or the firm's performance, but there is a lower limit.
  
  

Debt Seniority

• Preferred stock also shows some characteristics of debt instruments. An important consideration for debt instruments is seniority. Senior debt is paid before subordinate debt. Preferred Stock is subordinate to bonds but is senior to common stock. If a firm goes bankrupt, bondholders will be paid first, then holders of preferred stock. Holders of common stock will only receive what is left.
  
  

Options

• An option is an instrument entitling the holder to purchase or sell an asset at a prearranged price during a prearranged window of time. A call option imbues the holder with the right, but not obligation, to purchase an asset at a given price, called the strike price. The option's purchaser hopes that the asset will increase in value and that exercising the option allows her to acquire it at a discount. The put option allows the option holder to sell an asset at a given price. Someone who holds a security, and wishes to hedge against a collapse in its value, may purchase a put option. This would allow the holder of the option to sell the asset at the strike price, even if this price is below the current market price of the asset when the option is exercised. After the expiration date the option is worthless. Some options are allowed to expire in this manner. Obviously, an investor would not exercise the option unless it was profitable to do so. Holders of options may also trade out the option as it is itself a transferable security. Note that employee stock options are typically not transferable. Also, while those who hold options have the right but not obligation to exercise them, those who write the options are obligated to buy or sell the underlying asset if the holder of the option does choose to exercise it.