Options Terminology 101

Kicking off the first options post to explain some of the most basic terms one must know before even attempting to make an options trade.  There are several important terms an options trader should understand like WTF is a call option and what is a put option.

Here are some general definitions:

call option:

A contract that gives the buyer the right, but not the obligation, to buy a 100 shares of a specific stock at a predetermined price within a limited period of time.  The writer/seller of the option is obligated to SELL the 100 shares if the option is “in-the-money” at expiration if assigned.

put option:

A contract that gives the buyer the right, but not the obligation, to sell a 100 shares of a specific stock at a predetermined price within a limited period of time.  The writer/seller of the option is obligated to BUY the 100 shares if the option is “in-the-money” at expiration if assigned.

holder:

The buyer of the option.

premium:

The dollar amount paid by the buyer of the option to the seller.

writer:

The option seller.

strike price:

The predetermined price at which a given stock option contract can be bought or sold. Also called the exercise price, these levels are set at regular intervals. For example, if Apple’s (AAPL) stock was at 620, AAPL option strike prices would be 600, 605, 610, 615… and so on.

intrinsic value

The amount an option is in-the-money. Obviously, only in-the-money options have intrinsic value.

time value:

The part of an option price that is based on its time to expiration. If you subtract the amount of intrinsic value from an option price, you’re left with the time value. If an option has no intrinsic value (i.e., it’s out-of-the-money) its entire worth is based on time value.

expiration:

Monthly options expire on the 3rd friday of each month.  For example AAPL 620 Nov Call would expire on the 3rd friday in the month of November.  Weekly options, which are relatively new, expire each week on friday.  Weekly options are usually issued on Thursday the week before they expire.

at-the-money:

An option is at-the-money when the underlying stock price equals, or nearly equals, the strike price. For example, a AAPL put or call option is at-the-money if the option strike price is 620 and the price of the Apple’s stock is at, or near 620.

in-the-money:

A call option is in-the-money when the underlying stock price is greater than the strike price. For example, if Apple’s stock price is at 620 and the AAPL call option strike price is 615, the call is in-the-money. The put option is in-the-money when the strike price of the option is greater then the price of the underlying stock options contract. For example, if the strike price of the put option is 620 and AAPL stock is trading at 615, the put option is in-the-money.

out-of-the-money:

A call option is out-of-the-money if the strike price is greater than the underlying stock price. For example, if AAPL stock price is at 625 and the call option has an 615 strike price, the option is out-of-the-money. The put option is out-of-the-money if the underlying stock price is greater then the strike price. For example, if AAPL stock is are at 615, and the AAPL put option strike price is 620, the put option is out-of-the-money.

If you want to dig deeper into additional terms related to options, below is a nice link to the Options Industry Council – Options Glossary:

http://www.optionseducation.org/tools/glossary.html

Enjoy!!