Tuesday, October 22, 2013

Options Basics

Options are a contract between 2 parties where one party has the right (but no obligation) to buy or sell an underlying asset at a fixed price at a future date.

2 types:
Call - right to buy an asset at a fixed price
Put - right to sell an asset at fixed price

There are 2 parties involved - the buyer of the contract and the seller (option writer).
The fixed price is called strike price/exercise price.

American option: Can be exercised on any date up to and including the expiration date.
European option: Can be exercised only on expiration date.

Option writer is "short" on the contract
Option buyer is "long" on the contract

Stock options:

Price of buying the option: Option Premium
By convention, all traded options expire on the Saturday following the third Friday of the month.

At-the-money: Current price of stock = exercise price of option
In-the-money: Payoff from exercising an option immediately is positive. More positive ones are called Deep-in-the-money.
Out-of-the-money: Payoff from exercising an option immediately is negative. More negative ones are called Deep-out-of-the-money.

Stock option prices are always written on 100 shares of the stock.
Option prices are however quoted on a per-share basis.
Therefore, an ask price of $3.30 implies that you would pay 3.30 x $100 = $330 for the contract.

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