What is Option Stock?

Option stock is publicly-traded stock that qualifies to have options trading in the underlying security. Options convey the right, but not the obligation, to buy or sell shares of stock at a set price (strike price) during a predetermined period of time. Options are a wasting asset because they have an expiration date and can expire worthless. Therefore, the time value of the option drops each day closer to the expiration date. For U.S. options, the expiration date is always the Saturday following the third Friday of the month.

Function

Stock options serve several purposes. They can be used as an employee incentive or bonus. They can be used as a hedge against a negative move in the price of a stock. And they can be used on a strictly speculative basis, to take advantage of a price swing in a stock without having to invest the amount required to actually own the stock.

Types

There are two types of stock options. They are calls and puts. Investors buy calls when they believe the price of a stock is going to increase. Investors buy puts when they believe the price of a stock is going to decrease.
For example, let's say XYZ is currently $10 per share and Tom the Trader believes the price is going to go up. Tom might buy a $12.50 call option, giving him the right (but not the obligation) to buy the stock for $12.50. Before the expiration date, the stock goes to $16 per share. Tom exercises his option and buys the stock for $12.50, even though it is currently trading at $16. The difference is his profit.
Conversely, let's say Tom thinks the stock is going to go down. He buys a $7.50 put option. Let's assume he's right and the stock drops to $5 per share before expiration. Tom's option gives him the right to sell XYZ at $7.50 per share even though the stock is only trading at $5. Again, the difference is his profit.

Time Frame

Option expiration is a very important consideration. Stock options trade every month of the year, and an investor can select an option for one month or for six months or more. However, the longer term the option, the more expensive it will be because there is a longer time frame for the stock to reach the price target. This is known as the time value of an option.

Size

All U.S. stock options represent 100 shares of the underlying stock. In order to calculate the price of an option, take the quoted price and multiply by 100. For example, if an option is quoted at $1.25, the cost of that option is $125.

Warning

Options involve a high degree of risk and therefore investors must be approved to trade options by their brokerage. Only seasoned investors should invest in stock options.