Introduction to Options

Definition

An option is a contract that gives the owner the right (but not necessarily the obligation) to buy or sell an underlying security at a specific price on or before a certain date. To put it another way, the owner of an option gets to choose whether or not to buy or sell the underlying asset at a specific price on or before a fixed date.

Key Option Attributes

An option contract will have four important attributes:

• Underlying security – typically a commonly traded security such as a stock, future or commodity. This is the asset that can be bought or sold by the owner of the option.
• Type – there are two types: Call or Put. A Call gives the owner of the option the right buy the underlying asset. A Put gives the owner of the option the right to sell the underlying asset. An option can be either a Call or a Put but never both, so the holder has the right to buy or sell (but not both).
• Strike Price – the price that the underlying asset can be bought or sold at.
• Expiration Date – the last day that the buyer of the option can make the choice to buy or sell.

Exercising

For an option holder, the act of choosing to buy or sell the underlying asset is termed "an exercise" when used as a noun or "to exercise" when used as a verb. The two most common exercise conventions are:

• American – can be exercised on any trading day on or before the expiration date
• European – can be exercised on the expiration date only

Standardized Options

MarketChameleon.com exclusively displays information regarding standardized stock options. "Standardized" means that a governing/regulatory body has chosen all combinations of underlying security, strike price and expiration date that are available to the investor. Alternatively, with an "over-the-counter" (OTC) option, the investor can specify the option attributes. This tutorial will not discuss OTC options and will treat "stock options" and "standardized options" as one and the same.

Stock options use the American exercise convention. Option underlying securities are chosen from a pool of relatively liquid common stocks, ADRs and ETFs.

Available strike prices are typically available in increments within a range around the current price of the underlying security. An "at-the-money" (ATM) option is the one that has the strike price which is the closest to the current price of the underlying security. Options can also be classified as "in the money" and "out of the money" based on the strike price, underlying price and option type. This is illustrated in the table below:

Expiration dates are typically available on the Friday of the current week, on the 3rd Friday of the current or next month and the 3rd Friday of several upcoming months. Longer expirations are usually available.

Viewing the Option Chain on MarketChameleon.com

Follow these steps to display the Options Chain page for an underlying stock on MarketChameleon:

1. Enter the ticker symbol in the search box in the top right corner of the site
2. Press Enter or click on the search icon to go the the symbol's Overview page
3. When the page loads, you should see a menu on the left-hand side. "Option Chain" is listed under the "Option" section of the menu
4. If there is no "Option" section, it is likely that the product you're looking at does not have options currently listed on an exchange

Example

A call option on Apple Inc (AAPL) stock with strike 114 and expiration date 23-Sep-16 can be labeled "AAPL 23Sep16 C 114". If the AAPL stock price falls below the strike price for example to $108, then this option is out-of-the-money. If it expires out-of-the-money, the options have no value, and the investor loses only the premium paid to purchase the options. If the AAPL stock price rises above the strike price for example to $117, then this option is in-the-money, and the shares within the option contract have an intrinsic value of $3.00. This option can be exercised on any day up to and including 23-Sep-2016.