a security created between two parties in expectation of a future upward or downward movement of the price of a particular stock.
What are the 2 types of options contracts:
The CALL and the PUT.
Explain a CALL OPTION scenario:
if the buyer of the call option chooses to exercise the call option, the person who sells (writes) the option contract is obligated to sell the stock to the buyer of the contract at the exercise price.
Explain a PUT OPTION scenario:
if the buyer of the put option chooses to exercise the put option, the person who sells (writes) the option contract is obligated to buy the stock at the exercise (or strike) price.
BUYERS of option contracts are hoping to:
profit from a movement in the market price of the underlying stock during the option period, without making an investment in the stock itself.
BEING LONG AN OPTION means:
that investors have purchased and therefore own the option, and can exercise at their discretion.
Being long an option gives purchasers the opportunity to exercise.
These investors have paid money for the option.
BEING SHORT AN OPTION means that:
an investor has sold, or written, the option.
The investor has an obligation if the option is exercised.
Being short an option obligates the investor to act if a buyer of the option decides to exercise that option.
Buyers of options are considered to be:
"long the option"
WRITERS of option contracts are hoping to:
profit either from a lack of movement in the price of the stock, or a movement in the opposite direction from the buyer's interest during the option period.
Writers are considered to be:
"short the option"
An EQUITY CALL OPTION gives the purchaser:
the right to buy 100 shares of the underlying stock at the exercise price any time prior to the expiration date.
If buyers of the call exercise, they will buy the stock from a writer of the call.
An EQUITY PUT OPTION gives the purchaser:
the right to sell 100 shares of the underlying stock at the exercise price any time prior to the expiration date.
If the buyer of the put exercises, the writer of the put will have to buy the stock.
Buyers of puts only exercise writers of puts.
The EXERCISE PRICE is also known as the:
STRIKE PRICE. The exercise price is the price at which the purchaser of the option can buy or sell 100 shares of the underlying stock any time prior to expiration.
The size of each option contract is:
The _________________ determines the size of the option contract based on the type of option
Options Clearing Corporation (OCC)
For stock options, the size of each contract is:
100 shares of the underlying stock
For foreign currency options, the size of each contract is:
predetermined, but changes from currency to currency.
In Options, the amount of money paid by the buyer of the option contract for the privilege to exercise is the:
The date that all options of that month expire and can no longer be exercised is called:
The EXPIRATION DATE
The CALL BREAKEVEN POINT is the:
break even point of all call options.
Think, CALL UP
Add the premium to the strike price to find the call breakeven point.
The PUT BREAKEVEN POINT is:
the breakeven point of all put options.
Think: PUT DOWNsubtract the premium from the strike price to find the put breakeven point.
The PUT BREAKEVEN POINT is:
The breakeven point of all put options.
Think, PUT DOWN subtract the premium from the strike price to find the put breakeven point.
A STRADDLE is the purchase or sale of:
both a Put and a Call on the same stock, with the same exercise price and the same expiration date.
A straddle always has two breakeven points.
one _____ the strike price and one _____the strike price.
When investors write options against their stock positions, they are doing so to:
generate income for their portfolio.
A quote of a call option looks like this: EGG SEPT 70c for 3
This quote is interpreted as follows:
EGG is the name of the company that issued the stock underlying the option.
September is the month that the option expires
The 70 is the strike price or exercise price at which 100 shares can be bought.
The letter "c" (or nothing at all) denotes that this is a call option.
The "3" is the premium on a per-share basis that would be paid by the purchaser of the option to the writer.
Since there are 100 shares per contract, this contract is selling for $300.
If investors sell stock short, they believe the stock will:
decrease in price, and thus can buy it back at a lower price
A Quote of a put option looks like this:
EGG MARCH 30p for 4.
The quote is interpreted as follows:
EGG is the underlying stock.
March is the month the option expires.
The 30p signifies an exercise price of $30, with the "p" denoting that this is a put (calls have a "c" or nothing after the price), and it is the price at which 100 shares of stock can be sold at a guaranteed price.
The "4" is the price of the option on a per share basis, or $400 because the contract is for 100 shares.
Investors incorporate option positions to enhance their stock positions. They do this in one of two ways:
Buying options to protect their stock
Writing options for income
When investors buy options to protect their positions, they are considered to be:
HEDGING their position. This strategy is the best way to protect themselves from loss, as the option guarantees them a price for their stock for a certain length of time.
Think of hedging as limiting losses or the protection of a stock position. To hedge, investors purchase the option. If investors have purchased stock, they want the stock to rise in price. If investors purchase a put, and instead the price of the stock falls, they have protected themselves. The put allows the investor to sell the stock at a guaranteed price.
The three main interest rate options are:
Options on the one-year Treasury bill
Options on the two-year Treasury note
Options on the 30-year Treasury bond
INDEX OPTIONS are based on one of the many indexes that show the movement of stock, such as: