For those that are probably simply just starting into getting to know how to trade options or trying to find out what options is, here’s a number of explanations of the various common terminology you are going to encounter later in your trading career.
Call option is a financial contract between two parties, the buyer and the seller of this type of option. It is the option to buy shares of a stock at a specified time in the future.
The buyer of the option has the right, but not the obligation to buy an agreed quantity of a particular stock from the seller of the option at a certain time(the expiration date) for a certain price(the strike price) .
However, the seller(or “writer”) is obligated to sell the stock should the buyer decides to exercise his/her right on the option. The buyer pays a fee(called a premium) for this right.
Put option is a financial contract between two parties, the seller(writer) and the buyer of the option. The buyer acquires a short position with the right, but not the obligation, to sell the stock at an agreed- upon price(the strike price) . If the buyer exercises his right to sell the option, the seller is obliged to buy it at the strike price. In exchange for selling his/her stock to the buyer, the buyer pays the writer a fee(the option premium) .
Strike price, also referred to as exercise price is the price at which the owner of an option can purchase, in the case of a call, or sell, in the case of a put, the underlying stock. It’s the price at which the stock will be bought or sold when the option is exercised.
Premium is the price that buyer pays the seller for carrying the risk for the obligation. This is similar to insurance premium where you pay the insurance company a premium, so in case if anything happens, the insurance company is obligated to compensate the damage. The price of the premium depends on many different factors such as strike price, time left until expiration date, interest rate, volatility, etc.
Expiration Date – Options is a wasting asset, meaning that it loses value as time goes by. Once the option expires, the option no longer has any value and become worthless. The expiration date is found in each option contract when it is bought.
American Style and European Style Option – There are two different types of options. American style option is one where buyers can choose to exercise the option any time up until the expiration date whereas the European style option is where buyers can only exercise on the expiration date.
These are only the various most common terms you’ll see when starting out in option trading. If you’re serious about discovering how to trade stock options, then you might want to adhere to a few of the basic option trading tips that every option trader would adhere to.
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