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Options Explained

What Are Options?

An option is a contract giving the buyer the right, but not the obligation, to buy or sell an underlying asset (a stock or index) at a specific price on or before a certain date (listed options are all for 100 shares of the particular underlying asset).

For Example:

  • Call option – If you buy have a call option, you have the right to buy 100 shares of a particular stock at a predetermined price, which is called the “strike price.” before the expiration date. Having a call option obligates the current owner of those shares to sell them to you according to the option agreement.
  • Put option Having a put option means you have the right to sell shares at the strike price by the expiration date. If you exercise your put option, the shares must be sold and you’ll collect the strike price for each.
  • Strike price – of an option is the price at which a put or call option can be exercised. It is also known as the exercise price. Picking the strike price is one of two key decisions (the other being time to expiration) an investor or trader must make when selecting a specific option.
  • Out of the money – “Out of the money” (OTM) is an expression used to describe an option contract that only contains extrinsic value. These options will have a delta of less than 50.0. An OTM call option will have a strike price that is higher than the market price of the underlying asset. You will get a much bigger return if a bigger move happens
  • In the money – In the money” (ITM) is an expression that refers to an option that possesses intrinsic value. … An in-the-money call option means the option holder has the opportunity to buy the security below its current market price. In the money you will get a much smaller return if a bigger move happens
  • PREMIUM – An option premium is the current market price of an option contract. It is thus the income received by the seller (writer) of an option contract to another party. In-the-money option premiums are composed of two factors: intrinsic and extrinsic value. Out-of-the-money options’ premiums consist solely of extrinsic value.

For stock options, the premium is quoted as a dollar amount per share, and most contracts represent the commitment of 100 shares.

 

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