Options Basics
An option lets you buy or sell a certain quantity of an underlying asset at a fixed price before an expiry date. It is a financial contract in which the holder has the right (but not the obligation) to buy (in the case of a call option) or sell (in the case of a put option) a specified quantity of an underlying security at a specific price (strike price) within a fixed period of time (until its expiration).
For the writer of the option, it represents an obligation to sell (in the case of a call option) or buy (in the case of a put option) the underlying security at the strike price anytime before the expiration date.
The Underlying Asset
Options are derivatives. In the financial world, a derivative is a financial instrument which derives its value from the value of another financial instrument. Stock options derive their value from the price of the underlying stock and each contract covers 100 shares.
Calls & Puts
There are 2 types of options - calls and puts. Call options let the holder buy the underlying asset while put options allow the holder to sell them.
The Strike Price
The strike price or exercise price is the price at which the underlying asset can be bought or sold upon exercising the option. Its relation to the underlying asset price affects the moneyness of the option and is a major determinant of the option's premium.
Option Expiration
Options are wasting assets and every option is defined by an expiration month. Equity options listed in the United States expire on the third Friday of the expiration month
Naming Convention
Throughout this website, the following naming convention is used to simplify the identification of options:
[Underlying Asset] [Expiration Month] [Strike Price] [Option Type]
Eg. IBM JUL 25 Put
The above example represents a put option whose underlier is 100 shares of IBM stock, has a strike price of $25 and expires in July.
