Options Terminology 101
My objective of making one million dollars a year is dependent on my options trading. Each week, I buy and sell options on a variety of stocks for the purpose of turning a profit. And at the end of the week, I share the detail on all of my trades.
But what if you aren’t familiar with options terminology, or what they are? Then that detail probably doesn’t make much sense to you. If this is where you are, then please keep reading. I will provide you with a basic training on options and the terminology used when talking about them.
What is a Stock Option
First, what is a stock option? Put simply, it’s an agreement to buy or sell a specific stock, at a specified price, on or before a specific date. When you buy or sell this option, you are trading either a CALL or a PUT, for a certain strike price, and a certain expiration date.
Strike Price– this is the stock price which the option is good for.
Expiration Date– options expire at close of trading on the expiration date.
In the Money– when the price of a stock exceeds the strike price of a CALL option, that option is considered In the Money. That option can be exercised at any time prior to expiration for a potential profit. When the price of a stock falls below the strike price of a PUT option, that is when it is In the Money.
Out of the Money– when the price of the stock falls to below the strike price, the CALL option is considered Out of the money. It will be worthless at expiration. When a stock price rises above the strike price of a PUT option, that option is considered Out of the Money.
CALL– when you buy a CALL option, you are buying the option to buy the stock, at the specified strike price, on or before the expiration date. If you sell a CALL option, you are giving someone else the option, but not the requirement, to buy the stock from you at the strike price. You typically buy a CALL option if you think the price of the stock will be above the strike price before expiration (In the Money). If the stock rises above the strike price, you can buy it at the lower strike price and sell it for the higher market price for a profit.
You would typically sell a CALL option if you believe the stock price will never rise to or above the strike price. When the stock price doesn’t exceed the strike price at expiration (remains Out of the Money), the option is considered worthless and you keep the amount you sold it for.
PUT– when you buy a PUT option, you are buying the option to sell a stock, at the strike price, on or before the expration date. If you sell a PUT option, you are giving someone else the option, but not the requirement, to sell you the stock at the strike price. You typically buy a PUT option if you think the price of the stock will be below the strike price (In the Money) before expiration. If the stock falls below the strike price, you can buy the stock, and then exercise the option and sell it at the higher stike price for a profit.
You would typically sell a PUT option if you believe the stock will remain above the strike price (Out of the Money) at expiration. When this occurs, the option is considered worthless and you keep the full amount you sold the option for.
One thing to remember, when you buy an option, you can execute it (assign it) at any time prior to expiration. You don’t have to wait for expiration. So if you buy a CALL option, and the price of the stock rises way above the strike price, and you think it will fall again before the option expiration, you may want to go ahead and execute it or sell it early to lock in your profit.
The flip side of this is that when you sell an option, the other party can execute it at any time. You have to be prepared that any CALL or PUT that you’ve sold can be exercised on you at any time when it’s in the money. Unfortunately, you have no control over when the owner of the option decides to execute it up to expiration.
A Contract is 100 Shares
One other thing to keep in mind, option contracts deal with 100 shares at a time. When you buy a CALL or a PUT, you are buying the option to Buy or to Sell 100 shares of that stock. If you buy 10 option contracts, you are buying the right to buy or sell 1,000 shares. When pricing an option, they will show you the price per share, so you always need to multiply that price by 100 to know what the contract cost is.
This should give you a lot better idea of the basics of options trading. But there is a lot more to know. There are strategies like spreads, strangles, etc., things like intrinsic value, and the greek terms alpha, beta, and gamma. I’ll try to cover some of these in future posts.