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Options Basics

Purchasing an option gives the buyer the right, but not the obligation, to buy or sell a specific amount of an underlying security at a specific price within a specified time period. By comparison, a futures contract requires both the buyer and the seller to perform under the terms of the contract, if an open futures position is not offset before expiration.

The decision whether or not to exercise an option is entirely that of the options buyer.

An option buyer cannot lose more than the amount he or she invested in the options premium. The same cannot be said, however, for the buyer of a futures contract.

An option buyer is never subject to margin calls. This enables the buyer to maintain a market position, despite any adverse moves, without putting up additional funds.

Following are some further options basics:

•  Buying an option gives you the right to buy or sell an underlying security.
   
• As an options buyer, you have the right, but not an obligation, to buy or sell an underlying security at a specified price.
   
• As an option seller (writer), you have obligations to the options buyer.
   
• There are two types of options:
  • Calls (call options) - give you the right to buy an underlying security.
  • Puts (put options) - give you the right to sell an underlying security.
     
• Each option corresponds to 100 shares of an underlying security.
   
• The price of an option depends on several factors:
  • The current price of the underlying security;
  • The strike price of the option;
  • The amount of time remaining until the option expires;
  • The volatility of an underlying security.
     
• Strike Price. The price at which an underlying security can be purchased or sold, if an option is to be exercised.
   
• Expiration Date. The date on which an option expires. It is the 3rd Friday of the expiration month. Each option has an expiration day. After expiry, you have lost the right to buy or sell the underlying security at the strike price.
   
• Premium. The price of an option. If an option costs $3 per contract, your total premium is $300 (one contract = 100 shares), plus commission (transaction) costs.
   
• Please note that options are not available on every stock (i.e., not all stocks are optionable).

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