Understanding Equity Options - The Options Clearing Corporation

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Strike PriceThe strike price, or exercise price, of an option is thespecified share price at which the shares of stock canbe bought or sold by the holder, or buyer, of the optioncontract if he exercises his right against a writer,or seller, of the option. To exercise your option isto exercise your right to buy (in the case of a call) orsell (in the case of a put) the underlying shares at thespecified strike price of the option.The strike price for an option is initially set ata price which is reasonably close to the current shareprice of the underlying security. Additional or subsequentstrike prices are added as needed. New strikeprices are introduced when the price of the underlyingsecurity rises to the highest, or falls to the lowest,strike price currently available. The strike price, afixed specification of an option contract, should notbe confused with the premium, the price at which thecontract trades, which fluctuates daily.If the strike price of a call option is less thanthe current market price of the underlying security,the call is said to be in-the-money because the holderof this call has the right to buy the stock at a pricewhich is less than the price he would have to pay tobuy the stock in the stock market. Likewise, if a putoption has a strike price that is greater than the currentmarket price of the underlying security, it is alsosaid to be in-the-money because the holder of thisput has the right to sell the stock at a price which isgreater than the price he would receive selling thestock in the stock market. The converse of in-themoneyis, not surprisingly, out-of-the-money. If thestrike price equals the current market price, the optionis said to be at-the-money.PremiumOption buyers pay a price for the right to buy or sellthe underlying security. This price is called the optionpremium. The premium is paid to the writer,or seller, of the option. In return, the writer of a calloption is obligated to deliver the underlying security(in return for the strike price per share) to a call optionbuyer if the call is exercised. Likewise, the writerof a put option is obligated to take delivery of the10
underlying security (at a cost of the strike price pershare) from a put option buyer if the put is exercised.Whether or not an option is ever exercised, the writerkeeps the premium. Premiums are quoted on a pershare basis. Thus, a premium of $0.80 representsa premium payment of $80.00 per option contract($0.80 x 100 shares).American-Style ExpirationThere are three styles of options: American,European and Capped. In the case of an Americanstyleoption, the holder of an option has the right toexercise his option at any time prior to its expirationdate; otherwise, the option will expire worthless andcease to exist as a financial instrument. At the presenttime, all exchange-traded equity options are American-style.The holder or writer of any style of optionmay close out his position simply by making anoffsetting, or closing, transaction. A closing transactionis a transaction in which, at some point prior toexpiration, the buyer of an option makes an offsettingsale of an identical option, or the writer of an optionmakes an offsetting purchase of an identical option.A closing transaction cancels out an investor’s previousposition as the holder or writer of the option.The Option ContractAn equity option contract is defined by thefollowing elements: type (put or call), style (American),underlying security, unit of trade (number ofshares), strike price, and expiration date. All optioncontracts that are of the same type and style and coverthe same underlying security are referred to as a classof options. All options of the same class that have thesame strike price and expiration date are referred to asan option series.If a person’s interest in a particular series of optionsis as a net holder (that is, if the number of contractsbought exceeds the number of contracts sold),then this person is said to have a long position inthe series. Likewise, if a person’s interest in aparticular series of options is as a net writer (if thenumber of contracts sold exceeds the number of contractsbought), he is said to have a short position inthe series.11
Page 2 and 3: The Options IndustryCouncil (OIC) i
Page 4 and 5: Selling Equity Puts 30■ covered p
Page 6 and 7: The purpose of this booklet is to p
Page 8 and 9: FlexibilityOptions are an extremely
Page 10 and 11: Options Compared toCommon StocksLis
Page 14 and 15: Exercising the OptionIf the holder
Page 16 and 17: puts. Like other exchange-traded eq
Page 18 and 19: VolatilityVolatility is the propens
Page 20 and 21: Buying Equity CallsA call option co
Page 22 and 23: e exercised and you will own 100 sh
Page 24 and 25: you to cover your position prematur
Page 26 and 27: ever, if the price increase occurs
Page 28 and 29: Selling Equity CallsAs a call write
Page 30 and 31: The $6 per share difference between
Page 32 and 33: 1) If the market price of the stock
Page 34 and 35: subsequently drops from $55 to $45
Page 36 and 37: GlossaryAmerican-style option: An o
Page 38 and 39: In-the-money: A call option is in-t
Page 40 and 41: AppendixExpiration Cycle TablesThe
Page 42 and 43: For More InformationBATS Options Ex
Page 44 and 45: Notes42
Page 46: Notes44

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