He said that nothing in his proposal would require Americans who already have health insurance to change their coverage or doctor.
But he said he would make the insurance work better for individuals by prohibiting insurers from dropping coverage for sick patients or by capping it. He would also require insurers to cover the cost of routine check-ups and preventative care.
For the millions of uninsured Americans, he said he would create an insurance exchange - a market place where individuals and small business will be able to shop for health insurance at competitive prices.
Mr Obama said a public insurance option could help keep the private health insurance companies honest and competitive.
But he said it would not be subsidised by the government, so would not create unfair competition for the private sector.
He added that the public option was only a means to an end, and he remained open to other ideas if they had the same effect.
When Mr Obama said illegal immigrants would not benefit from his plan, the Republican ranks showed signs of near mutiny, says the BBC's Jonathan Beale in Washington.
HEALTHCARE IN THE US
46 million uninsured, 25 million under-insured
Healthcare costs represent 16% of GDP, almost twice OECD average
Reform plans would require all Americans to get insurance
Some propose public option to compete with private insurers
This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.