Option Trading Terminology
Purchasing an option contract gives you the benefit of leveraging your investments. In the case of stock options, a contract holder actually controls 100 shares of a stock, but only for a fraction of the cost compared to purchasing 100 shares outright.
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Basic Understanding
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When you purchase an option contract you are buying the underlying, or intrinsic, value of an asset like a stock or a market index. Purchasing an option gives you the right, but not the obligation, to buy or sell the investment product within a specific period of time. There are many types of options to choose from, including stock, commodity, currency, index and even debt options.
Strike Price
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Every option contract has a strike price that never changes. When the option reaches the strike price or rises above it, the option is said to be "in the money." At this point the investor can sell the call option, or buy the put option, and realize a gain.
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Premium
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The market value of an option is known as the premium. Many factors determine the option premium including the current price of its underlying asset, the option strike price, volatility and the time left until expiration. Once purchased, the premium fluctuates as the value of the underlying security changes.
Expiration Date
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Every option contract has an expiration date. You must take action to sell or buy the option, known as exercising it, on or before this date. If you allow the option to expire, it becomes worthless.
Call Option
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A call option gives you the right to purchase a certain amount of the underlying security at a specific price. A call option will benefit you if the value of the underlying security increases.
Put Option
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Purchasing a put option allows you to sell a specific amount of the underlying security at a certain price. Put options are beneficial when the underlying security value decreases and is comparable to shorting a stock.
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