Options: Option Language
To trade options, you'll have to know the terminology associated with
the options market. An option that is traded on a national options exchange such as the
Chicago Board of Exchange (CBOE) is known
as a listed option. These have fixed strike prices and expiration dates.
Each listed option represents 100 shares of company stock (known as a
contract).
- Underlying Security - The
security - such as XYZ Corporation - an option writer must deliver (in the
case of call) or purchase (in the case of a put) upon assignment of an
exercise notice by an option contract holder.
- Strike price - The strike
price, also called the exercise price, is the price at which an underlying
stock can be purchased or sold.
While the strike price is set by the exchange on which the option trades,
and does not change for the life of the option, the price of the
underlying instrument rises and falls, depending on supply and demand. As
a result, the underlying instrument might reach price that would make
buying at the strike price a good deal, or it might not. If not, you
simply let the option expire. This is the price a stock price must go above (for
calls) or go below (for puts) before a position can be exercised
for a profit. All of this must occur before the
expiration date.
- Exercise - When you act
on a buying or selling opportunity that you have been granted under the
terms of a contract, you are said to exercise a right. Typical contracts
include the right to exchange stock options for stock, buy stock at a
specific price, or buy or sell the security or other product underlying an
option at a specific price called the exercise price. For example, if you
buy a call option giving you the right to buy shares of a stock at $50 a
share, and the market price jumps to $60 a share, you would be likely to
exercise your option to buy at the lower price.
- Expiration Date - The Expiration
day for equity options is the Saturday following the third Friday of the
month. Therefore, the third Friday of the month is the last trading day
for all expiring equity options. This day is called "Expiration Friday".
For example, if you buy a September option, you can exercise it any time
until the end of trading on the third Friday in September. If the third
Friday of the month is an exchange holiday, the last trading day is the
Thursday immediately proceeding this exchange holiday. After the option's
expiration date, the contract will cease to exist. At that point the owner
of the option who does not exercise the contract has no "right" and the
seller has no "obligations" as previously conveyed by the contract. You
must exercise an option before its expiration date, or it expires
worthless. Options are available in three-, six- and nine-month contracts
- Premium - The total cost
(the price) of buying an option. This price is determined by factors
including the stock price, strike price, time remaining until expiration (time
value), and volatility.
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What
are LEAPs?
Long-Term Equity
AnticiPation Securities (LEAPs) are long-term options on stocks
that have expiration dates of one to five years rather than the
shorter terms (1 to 9 months) of most stock options. They are
virtually identical to regular options. LEAPS, however, provide
these opportunities for much longer periods of time. Although they
are not available on all stocks, LEAPS are available on most
widely-held issues. |
Next-->> Characteristics
of Options
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