Option contract parties
Every Options contract is a security with two parties attached to it (Owner/Buyer + Writer/Seller)
Call Option Buyer
has a right to buy at strike price.
- Pay a premium (and its per share)
- Hope option is exercised
- In control of option contract so can exercise it, let option expire, or close position
Call Option Seller
has an obligation to sell at strike price.
- Earn a premium
- Hope option expires (worthless)
- Not in control of option contract so cannot exercise it, cannot let option expire, they can close position (would have to buy it back)
Amount of shares in Option Contract
100 shares
Call Option: In the Money
options are in the money if they have intrinsic value
- For calls –> can you buy stock for less than its current market value
- Always exercised
Call Option: Out of the Money
options are out of the money if they have no intrinsic value
- Strike price is higher than the market value
- Always expire
Call: Long Position Gain/Loss
When having a long position: hope stock goes up
- Max gain: is unlimited, max loss: premium
Call: Short Position Gain Loss
When having a short position: hope stock goes down
- Max gain: premium, max loss: unlimited
Put Option Buyer
Owner/Buyer: right to sell at strike price
- Paid premium
- Hope to exercise it
Put Option Seller
Writer/seller: obligation to buy at strike price
- Earn premium
- Hopes it expires
Put Option: In the Money
For puts –> can you sell stock for more than its current market value
- Always exercised
Put Option: Out of the Money
- Strike price is lower than the market value
- Always expire
Long Put
right to sell stock
- Market View: want it to go down
- Max Gain = Strike price – Premium
- Max Loss = Premium
Short Put
obligation to buy stock
- Market View: Want it to go up
- Max Gain = Premium
- Max Loss = Strike price – Premium
Protective Put
Protecting your long stock position
- buy a put
Covered Call
Protecting your long stock position
- sell a call
Hedge a Short Stock Position
Buy a call
Option Expiration
- Options contract expire on the 3rd Friday of their expiration month
When do standard option contracts expire
- 9 months after issuance
American Style Options
Exercise at any time, Most equity options
European Style Options
Exercise at expiration only (only on expiration date)
Most index options
Index Options
use values of an index as the underlying asset (S&P 500)
Index vs Equity Options
Similar investment objectives as equity options
- Long puts can be used as hedge to protect an entire portfolio
Unlike equity options, index options are settled for cash (exercise value)
- No physical settlement
Volatility Market Index (VIX)
measures the volatility of S&P 500 index options
- Also referred to as the “fear index”
- This is inverted to the market
