Basic Options Terms

Options are good investing and speculative instruments. But options terminology may confuse even experienced investors. In this article we will take up some basic options terms.

Option - A contract that grants the holder the right, but not the obligation, to buy or sell a particular security at a predetermined price for a set period of time. The seller of the option has an obligation to fulfill the terms of the contract in the event of exercise by the option buyer.

Call Option - A contract that gives the buyer the right, but not the obligation, to purchase a specified amount of underlying security at a strike price anytime before the contract expires (if it is American style option) or at expiration only (if it is European style option). The call option buyer hopes the price of the shares will rise by a specific date while the put option seller hopes that the price of the shares drop or remain stable by the specified date.

For example: I write a call option with 100 Microsoft shares, strike at $35 and expiration date in July. Now I have an obligation to fulfill the terms of the contract. I get some money for this contract and I hope that price will be no more then $35. But if you as option buyer exercise contract I must sell you 100 Microsoft shares at $35 for each.

Put Option - An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a strike price within a specified time. The put option buyer hopes the price of the shares will drop by a specific date while the put option seller hopes that the price of the shares rise or remain stable by the specified date.

For example: I write a putt option with 100 Microsoft shares, strike at $35 and expiration date in July. I get some money for this contract and I hope that price will be no less then $35. But if you as option buyer exercise contract I must buy from you 100 Microsoft shares at $35 for each.

Underlying Security - The stock, commodity, futures, or other financial instrument on which an option contract is based.

example: In previous examples underlying security is Microsoft stock.

Strike Price or Exercise Price - The price, specified by the option contract, at which the holder can buy or sell the underlying security.

Expiration Date - The date on which an option and all rights associated with it ceases to exist. Expiration Date is the last day on which an option may be exercised.

Expiration - The date and time after which an option may no longer be exercised.

Exercise - Holder may to invoke the right associated with a particular option contract. When exercising a call option, the holder buys stock at a strike price from the option seller. In the case of a put, the holder of the option sells the stock to the option seller at the strike price.

Automatic Exercise - The automatic exercise of an in-the-money option at expiration by the clearing firm.

Premium - the total price of an option including both intrinsic and extrinsic or time value.

In-the-Money Option - A call option is in-the-money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security At-the-money - An option is at-the-money if the strike price is the same as the current market price of the underlying security.

Out-of-the-Money - An option with strike price is above (in the case of a call) or below (in the case of a put) the current market price of the underlying security.

Intrinsic Value - The portion of an option's price that can be account for by the amount the option is in-the-money. Intrinsic Value=Oprion price - Time Value (for options is in-the-money)

Time Value or extrinsic value - The amount by which the current price of an option exceeds its intrinsic value. The price of out-of-the-money and at-the-money options is made up exclusively of extrinsic value

Options may be risky, but your can control and reduce risks. If you are newbie in options, buy some books, visit some seminars or online trainings before buy or sell your first option.

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