Options Explained
A contract to buy or sell a definite financial product referred to as the option’s underlying instrument officially, is known as options. In the case of Equity Options; an Exchange Traded Fund (ETF), a stock, or any such product is known as the underlying instrument.
There’s precision with the contract itself; a specific price is established which is known as the strike price; this is the price at which the contract can be acted on or exercised. There is also a specified expiration date for an option. At the expiration of an option, it becomes valueless and ceases to exist.
Calls and Puts are the two varieties of Options; the investor can purchase or sell any of these. Your decision whether to buy or sell, and whether to opt for a Call or Put depends on your targeted goal as an Options investor.
Buying and Selling Options
The investor who purchases a call is given the right to buy the underlying instrument on or prior to the expiration date at the strike price. Whichever way, the option holder automatically has the right to let the option expire, or sell to another buyer during its term.
You are presented with a different scenario if you write, or ‘sell to open’ an option. The writer is obligated to keep his/her part of the contract when selling to open a short option position, where it is the wish of the holder to exercise. A situation where you sell a call as an opening transaction, you are under obligation to use the strike price as the selling price of the underlying interest, if you are assigned. You are under obligation to buy the underlying interest if you sell a Put as an opening transaction, if assigned.
The writer cannot exert control concerning whether or not a contract is exercised; as a writer, it is important to know that exercise can be done at any time pending the expiration date. However, in the same way that a buyer can choose not to exercise an option but sell it back into the market, the writer can buy an offsetting contract on the condition that such writer has not been assigned, brings an end to the obligation to meet the contract’s term. You will enter a “buy to close” transaction at the time of offsetting a short option position.
Values of Options
The measurement of what a particular options is worth to the seller or buyer depends on the possibility of the options to meet their expectations. Using the terminology of Options, that depends on if or not the option is, or is expected to be out-of-the-money or in-the-money when it is expiring.
When the underlying stock’s present market value is higher than the exercise price of the option, a call option is in-the-money. If the stock is less than the exercise price, a call option is out-of-the money.
For the put option, it is in-the money when the underlying stock’s present market value is less than the exercise price; but if the value is above exercise price, it is out-of-the-money.
Category: OPTIONS BASICS
