Key Options Terms and Definition

Key Options Terms and Definition

Below are some of the terms that will help the new entrant in the world of Options to understand the business of Options:

Definition of Option: Options are contracts between the buyer and seller giving the owner(buyer) the right (not obligation) to buy or sell an asset at a fixed price (called the “strike price”) on or before the Expiration Date.

The Options has the following attributes:

·        Underlying Security

·        Expiration Date

·        Strike/Exercise Price

·        Type of Contract (Call/put)

·        Premium

Underlying Security: This is the underlying security or financial instrument to which the option is associated.

Expiration Date: This is the date on which the Option Contract is either exercised or ends Worthless. Unlike Stock, Options are valid for a specified time. The time can be week, month or ever couple of years.

Seller: Also known as Writer of the Contract is the person who writes the contract promising the Buyer of the contract to Buy/Sell the stock at the Strike price on or before the expiration date.

Buyer: Also known as Owner of the Contract is the person who pays premium and has the right (but not obligation) to Buy/Sell the stock at the Strike price on or before the expiration date.

Call:  A Call option is a contract that gives its holder (buyer) the right to purchase shares of the underlying Stock/Equity at the Strike Price on or before the Expiration Date.

Put: A Put option is a contract that gives its holder (buyer) the right to Sell shares of the underlying Stock/Equity at the Strike Price on or before the Expiration Date.

Strike Price — Also referred as “Exercise Price” is the pre-agreed price per share at which stock may be bought or sold under the terms of an option contract. The Exercise price can be either above or below the current market price of the underlying security.

Intrinsic Value — The money value the Option has if it is exercised immediately. It is the difference between the Current Price and Exercise price.

For Call Options

·         If the Strike Price is less than the Current Price, the intrinsic value is (Current Price – Strike Price).

·         If the Strike Price is more than the Current Price, the intrinsic value is 0.

For Put Options

·         If the Strike Price is more than the Current Price, the intrinsic value is (Strike Price - Current Price).

·         If the Strike Price is less than the Current Price, the intrinsic value is 0.

Time Value — The part of an option price that is based on its time to expiration. If you subtract the amount of intrinsic value from an option price, you’re left with the time value. If an option has no intrinsic value (i.e., it’s out-of-the-money) its entire worth is based on time value.

Factors determining the Time Value