Options in a Brokerage Account
Upon approval, options can typically be traded and held in a brokerage account that holds stocks.
Options are traded in units called "contracts". A single contract gives the right to buy or sell a pre-determined number of shares of the underlying security which is typically 100, but this can vary.
Premiums
The price of an option is known as the "premium". The premium is expressed in USD per share of underlying security.
The premium for any given option is determined by the forces of supply and demand in the market,
but it is based on factors such as whether it is in-the-money or out-of-the-money, how much time remains
until expiration and whether it’s a call or put. A discussion of option pricing appears in a separate section.
On MarketChameleon.com, current option premiums are displayed in "Bid" and "Ask" columns in the Option Chain page, but data is delayed by at least 15 minutes. There are two sets of "Bid" and "Ask" columns: the set on the left is for Calls and the set on the right is for Puts.
Clicking on a value in the "Quantity" column brings up a Trade Summary window for that option contract.
The Trade Summary shows recent trades (if any exist) in the option contract and the premium paid is displayed in the "Price" column.
The total cost of an option contract to be paid by the investor is computed by multiplying the premium
by the "Contract Multiplier" of the option contract which is typically 100.
Exercising
An option can be exercised just once or not at all. After an option is exercised, its position is removed
from the brokerage account and the underlying security is added.
After an option expires it becomes worthless and it is removed from the brokerage account. Be aware that
explicitly requesting the brokerage to exercise an option prior to expiration is unusual because:
- For expiring options, the brokerage will automatically exercise those that are in-the-money
-
For in-the-money options that are not expiring, it is typically more profitable to sell the
option instead of exercising it. This is because when an option is exercised, the time value of
the option is lost, but when it is sold the time value is recouped in the premium.
Example
A "straddle" is an equivalent quantity of a call and a put for a given underlying security,
strike and expiration. An investor wants to purchase 1 straddle of Apple Inc (AAPL) at 114 expiring 23-Sep-2016.
- One contract of the call "AAPL 23Sep16 C 114" is purchased, the premium is $0.79/share and the total cost is $79.00.
- One contract of the put "AAPL 23Sep16 P 114" is purchased, the premium is $0.36/share and the total cost is $36.00.
- Total cost to buy the straddle is $115.
The price of AAPL stock is $117 on the day of expiration. It is desirable to exercise
the call because the investor will purchase the call at the strike price which is $114 which is
$3 below the prevailing market. Exercising the call will cause the investor purchase 100 shares
of AAPL stock at $114/share for a total outlay of $11,400. Then the investor can turn around and
sell the AAPL stock at market price and lock in a profit. Exercising the put does not make sense
at this point and it should be allowed to expire.
Positions before exercise:
- AAPL 23Sep16 C 114 – 1 contract
- AAPL 23Sep16 P 114 – 1 contract
Positions after exercising the call:
- AAPL – 100 shares
- AAPL 23Sep16 P 114 – 1 contract
Selling 100 shares of Apple stock at the prevailing market price ($117) brings in $11,700. Cost
of purchasing the Apple shares upon exercise was $11,400. There is $300 in profit generated
from trading the stock. The cost of the options ($115) must be factored in so the net profit
on this straddle is $185.
