Options Flashcards Preview

Third Friday of expiration month

Third Friday of the month at 11:59 p.m.

T + 2 (regular way settlement)

LEAPS

Options Clearing Corporation (OCC)

9 months

A type of options contract that can be exercised by the buyer at any point prior to expiration. Most equity-based options are American-style.

A term used to describe an option when the market value of the underlying stock is equal to the strike price. In this situation, the option will remain unexercised, with the buyer losing the premium and the seller gaining the premium.

The action taken by the OCC at expiration for all options that are in-the-money by at least $0.01 unless the customer gives other instructions.

The attitude of an investor who believes that stock prices will fall. Bearish strategies include selling stock short, selling calls, and buying put options.

The market value for which an investor has no profit or loss on a position.

The attitude of an investor who believes that stock prices will rise. Bullish strategies include purchasing stock, buying calls, and selling put options.

Has the right to buy shares at a set price until expiration of the contract. In return for this right, the call buyer pays a premium. Because investors want to exercise this right as prices increase, these investors are bullish on the stock.

An option contract that gives the purchaser the right to buy the stock at a set price and the seller the obligation to sell the stock at a set price.

A dollar amount above par that an issuer may pay an investor to compensate the investor when the issuer redeems the bonds prior to maturity. Typically, the earlier the call date, the higher the premium.

A trick to remember both the breakeven point and the in-the-money direction for call options. Call up reminds you to add the premium to the strike price to find breakeven and that calls are in-the-money whenever the market value is above the strike price. This is true regardless of whether the call is long or short.

Has the obligation to sell shares at a set price until expiration of the contract. In return for this obligation, call writers receive a premium. Because investors want the price to fall so the option expires, these investors are bearish.

Represents all calls or puts of an underlying issuer.

When an investor offsets his options position by repurchasing an option he originally sold or selling an option he originally purchased. When an investor closes his position, he is trading his option and effectively exiting the market. In this situation, the investor’s profit or loss is the difference between what he paid when buying the option compared to what he received when selling the option.

When an investor that wrote an option exits that position by repurchasing that same contract.

When an investor that owns an option exits that position by selling that same contract.

An option strategy in which an investor sells a call, while owning the underlying stock. It is considered a conservative strategy because if the call is exercised, the investor already owns the shares to make delivery, rather than having to buy the shares in the market at a much higher price. Investors benefit from the position through the income they earn from the premiums, which can also hedge some of their downside risk on the stock, while allowing them the potential to share in the long-term appreciation of their shares.

An investment whose value is tied to an underlying asset. Option contracts are an example.

A type of options contract that can be exercised by the buyer on the expiration date. Many stock index options are European-style.

The action taken by owners of calls or puts who want to effect the right afforded to them. When a call buyer exercises, she purchases the stock at a set price, and when a put buyer exercises, he sells the stock at a set price.

The termination date of an options contract, when an investor can no longer exercise his contract or liquidate her position. Options contracts typically expire on the third Friday of the month, nine months after the issue date. However, LEAPS can have expirations of up to three years.

When an investor takes a position with an opposite outlook and attitude in order to protect an existing investment. For example, an investor who owns stock might purchase put options as a hedge to protect his downside risk, and an investor who sold stock short might purchase call options as a hedge to protect her upside risk.

A term used to describe the situation when an option is exercisable by the owner because it has intrinsic value. Calls are in-the-money when the market value of the underlying stock is above the strike price, and puts are in-the-money when the market value of stock is below the strike price.

A type of option whose value is derived from the closing value of an entire stock index rather than a single stock.

A long-term option that can have an expiration of up to three years from the time of issuance. This is longer than the traditional nine-month expiration of most options.

The largest amount of losses an investor can incur on a position.

The largest amount of profits an investor can earn on a position.

A document that details the risks involved in options trading and must be received by customers at or prior to their accounts being approved for options trading.

A clearinghouse that issues and guarantees all listed options contracts, meaning those that are exchange-traded. The benefit of this guarantee is that the OCC acts as a counterparty, standing between buyers and sellers for every contract and thus protecting against risk of default.

A document that must be signed and returned by a customer within 15 days after account approval. It details the customer’s agreement to position limits and verifies that the customer has read and received the options disclosure document.

When an investor enters the options market by selling a call or a put.

When an investor enters the options market by purchasing a call or a put.

A term used to describe the situation when an option is not exercisable by the owner because it has no intrinsic value. Calls are out-of-the-money when the market value of the underlying stock is below the strike price, and puts are out-of-the-money when the market value of the stock is above the strike price.

The cost of an options contract. This is paid by the buyer (who is purchasing the right to either buy or sell) and received by the seller (who is taking on the obligation to either buy or sell). It can be calculated as time value plus intrinsic value.

A call option purchased by an investor to reduce the risk of an established short stock position. The call option allows investors to lock in a fixed purchase price to cover their short positions regardless of how high the value of shares goes.

A put option purchased by an investor to reduce the risk of an established long stock position. The put option allows investors to lock in a fixed sale price for their stock, regardless of how low the price declines.

Has the right to sell shares at a set price until expiration of the contract. In return for this right, put buyers pay a premium. Because investors want to exercise this right as prices fall, these investors are bearish on the stock.

A trick to remember both the breakeven point and the in-the-money direction for put options. Put down reminds you to subtract the premium from the strike price to find breakeven and that puts are in-the-money whenever the market value is below the strike price. This is true regard-less of whether the put is long or short.

An option contract that gives the purchaser the right to sell the stock at a set price and the seller the obligation to buy the stock at a set price.

Has the obligation to buy shares at a set price until expiration of the contract. In return for this obligation, put writers receive a premium. Because investors want the price to rise so the option expires, these investors are bullish.

The specific combination of a strike price and expiration within an option’s class.

The price at which an investor can exercise an option or warrant and buy or sell the underlying shares. This is set at issuance and does not change.

The portion of an option’s premium that reflects the time remaining until expiration. Options with a longer time horizon have more time value, as there is a greater chance that the option will go deeper into-the-money before expiration. Therefore, as expiration approaches, time value will decay toward zero. It can be calculated as the total premium minus intrinsic value.

Also referred to as a naked call, an option position in which an investor sells a call option without owning the underlying stock. This strategy has unlimited risk because no matter how high the stock price goes, the investor must always sell the shares at the strike price if exercised.

A strategy where an investor sells a put option without depositing cash equal to the exercise value of the option. This is risky because if the investor is forced to buy the stock at the strike price, he may not be in a strong position to meet the purchase obligation.

An option gives the owner the right, but not the obligation, to buy or sell 100 shares of the underlying security at some price, at some point in the future.

The price is called the strike, the right to buy is a “call,” and the right to sell is a “put”. Investor can both be long or short both calls and puts.

• Because they are bullish on the stock and think the price will increase
• It is less expensive than buying the underlying shares (the investor is paying the premium rather than the cost of actually purchasing the stock)
• To hedge a short stock position

• Buy means the investor is taking a long position in the contract and thus they will have the right to do something
• 2 reflects the number of contracts. Standard options contracts have 100 shares per contract. Thus in this example, 2 contracts each worth 100 shares for a total of 200 shares in this particular example
• XYZ is the security the investor is speculating on
• Oct is the expiration month. Most options contracts are issued with a 9 month expiration
• 40 is the strike price, which is where the investor has the right to exercise the contract
• Call is the class, which gives the investor the right to buy the stock at the strike price
• @3 is the premium, which is the cost of the contract. In this case, for the right to buy XYZ at $40 per share, the investor is paying a cost of $3 per share x 100 shares per contract x 2 contracts ($600 in total in this example)

The investor has an obligation to sell IBM stock at $30 if the option is exercised by the buyer between now and the expiration date of July

If the shares are trading above 30 at the time the option expires, the investor would want to take advantage of their right to buy the shares at 30.

Option contracts typically represent 100 shares per contract. Therefore, the premium of $1.50 per share is multiplied by 100 to arrive at the cost of $150 for the contract.

A put gives the owner the right to sell 100 shares of IBM stock at $30 per share. This investor would want to exercise their option if the shares were trading lower than 30 in order to sell the stock for more than it is actually worth.

Options expire on the third Friday of the month.

Buyers of options

• They are owners and open long positions (buying a call or buying a put)
• Buyers have a right to do something
• Pay a premium for that right

Sellers of options

• They are writers and open short positions (selling a call or selling a put)
• Sellers have an obligation to do something
• Receive a premium for that obligation

1. Buy a put - a right to sell stock
2. Sell a put - an obligation to buy stock
3. Buy a call - a right to buy stock
4. Sell a call - an obligation to sell stock

1. Buy Put - Bearish View
2. Sell Put - Bullish View
3. Buy Call - Bullish View
4. Sell Call - Bearish View

In-the-money means that the option is exercisable by the buyer of the option. Calls are in-the-money when the market value is above the strike price and puts are in-the-money when the market value of the stock is below the strike price.

• Sellers want to collect the premium and have the option remain unexercised - this means they want out-of-the-money options at expiration
• Buyers want to have in-the-money options at expiration so they exercise there option

The amount of money by which the option is in-the-money is called its intrinsic value. For example, if a call option has a strike price of $50 and the stock is trading at $60, the intrinsic value would be the in-the-money amount of $10. Remember, calls are in-the-money when the market value is above the strike price. If an option is out-of-the-money, then intrinsic value is zero (it cannot be negative).

Premium = Time value + Intrinsic Value

1. Intrinsic value is the in-the-money amount of the option
2. Time value reflects the amount of time remaining until expiration

Add the premium to the strike price.

Add the premium to the strike price.

The owners of a call will spend premium on the call so they want the stock to trade above the breakeven price. For puts the opposite is true. For owners of puts they want the stock to trade below the breakeven.

American and European

• American style can be exercised at any time prior to expiration
• European style can be exercised only at expiration

Closing an options position, means that the investor is liquidating position. If they initially bought an option, they will now sell it to close their position. If they initially sold an option, they will not buy it back to close their position.

The OCC issues and guarantees all options contracts. In doing so, they ensure the financials of the contract, which protects against default risk.

The OCC randomly assigns exercise notices to clearing firms, who then pass the notice along to a broker dealer, who then assigns to the customer in theory on a random basis.

Most options are set up by the OCC to expire nine months after issuance. Some contracts, known as LEAPs options, have an expiration of longer than nine months.

Most options are set up by the OCC to expire nine months after issuance. Some contracts, known as LEAPs options, have an expiration of longer than nine months.

The OCC randomly assigns exercise notices to clearing firms, who then pass the notice along to a broker dealer, who then assigns to the customer in theory on a random basis.

The OCC issues and guarantees all options contracts. In doing so, they ensure the financials of the contract, which protects against default risk.