Chapter 1: What is a Security? - F. Characteristics of All Options

All option contracts are issued and their performance is guaranteed by the Options Clearing Corporation (OCC). Standardized options trade on the exchanges, such as the Chicago Board Options Exchange and the American Stock Exchange.

All option contracts are for one round lot of the underlying security, or 100 shares. To determine the amount that an investor either paid or received for the contract, take the premium and multiply it by 100. If an investor paid $4 for 1 KLM August 70 call. They paid $400 for the right to buy 100 shares of KLM at $70 per share until August.

Exercise Price

The exercise price is the price at which an option buyer may buy or sell the underlying security, depending on the type of option involved in the transaction.

Buyer vs. Seller

Buyer Seller
Known as Owner Writer
Objective Long Short
Objective Maximum speculative profit Premium income
Wants the option to Exercise Expire

Possible Outcomes for an Option

-Exercised

If the option is exercised, the buyer has elected to exercise their rights to buy or sell the security depending on the type of option involved. Exercising an option obligates the seller to perform under the contract.

-Sold

Most individual investors will elect to sell their rights to another investor rather than exercise their rights. The investor who buys the option from them will acquire all the rights of the original purchaser.

-Expire

If the option expires, the buyer has elected not to exercise their right and the seller of the option is not required to perform.

Option Premiums

The price of an option is known as its premium. Factors that determine the value of an option and, as a result, its premium, are:

  • The Relationship of The Underlying Stock Price to The Option’s Strike Price
  • The Amount of Time To Expiration
  • The Volatility of The Underlying Stock
  • Supply and Demand
  • Interest Rates

An Option can be:

  • In The Money
  • At The Money
  • Out of The Money

These terms describe the relationship of the underlying stock to the option’s strike price. These terms do not describe how profitable the position is.

In The Money Options

A call is in the money when the underlying stock price is greater than the call’s strike price.

Example:

An XYZ June 40 Call is $2 in the money when XYZ is at $42 per share.

A put is in the money when the underlying stock price is lower than the put’s strike price.

Example:

An ABC October 70 Put is $4 in the money when ABC is at $66 per share.

It would only make sense to exercise an option if it was in the money.

At The Money Options

Both puts and calls are at the money when the underlying stock price equals the options exercise price.

Example:

If FDR is trading at $60 per share, all of the FDR 60 calls and all of the FDR 60 puts will be at the money.

Out of The Money Options

A call is out of the money when the underlying stock price is lower than the option’s strike price.

Example:

An ABC November 25 call is out of the money when ABC is trading at $22 per share

A put option is out of the money when the underlying stock price is above the option’s strike price.

Example:

A KDC December 50 put is out of the money when KDC is trading at $54 per share.

It would not make sense to exercise an out of the money option.

Calls Puts

In the Money

Stock Price > Strike Price

Stock Price < Strike Price

At The Money

Stock Price = Strike Price

Stock Price = Strike Price

Out of The Money

Stock Price < Strike Price

Stock Price > Strike Price

Intrinsic Value and Time Value

An option’s total premium is comprised of intrinsic value and time value. An option’s intrinsic value is equal to the amount the option is in the money. Time value is the amount by which an option’s premium exceeds its intrinsic value. In effect, the time value is the price an investor pays for the opportunity to exercise the option. An option that is out of the money has no intrinsic value; therefore, the entire premium consists of time value.

A. Introduction: Brokerage Office Procedures & Back Office Operations


Related Articles
  1. Professionals

    OPTION PREMIUMS

    Option Premiums The price of an option is known as its premium. Factors that determine the value of an option and, as a result, its premium, are: The Relationship of The Underlying Stock Price ...
  2. Professionals

    Option Premiums

    The price of an option is known as its premium. Factors that determine the value of an option and, as a result, its premium, are: The Relationship of The Underlying Stock Price to The Option&rsquo;s ...
  3. Professionals

    Calls And Puts

    Calls And Puts
  4. Professionals

    European vs. American Options and Moneyness

    CFA Level 1 - European Vs. American Options and Moneyness. Differentiates European and American options and contrasts the concepts of instrinic and time value. Also discusses the moneyness of ...
  5. Professionals

    POSSIBLE OUTCOMES FOR AN OPTION

    Possible Outcomes For an Option Exercised If the option is exercised, the buyer has elected to exercise their rights to buy or sell the stock depending on the type of option involved. Exercising ...
  6. Professionals

    Alternative Investments

    Alternative Investments
  7. Options & Futures

    Options Pricing: A Review Of Basic Terms

    The following is intended as a review of basic option terminology, which can be used as a reference as needed: American Options - An option that can be at any point during the life of the contract. ...
  8. Options & Futures

    What Is Option Moneyness?

    Get the basics under your cap before you get into the game.
  9. Professionals

    Options: Calls and Puts

    CFA Level 1 - Options: Calls and Puts. Learn the two main types of option derivatives and how each benefits its holder. Provides an example multiple choice question for an option.
  10. Options & Futures

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
RELATED TERMS
  1. In The Money

    1. For a call option, when the option's strike price is below ...
  2. Call Over

    When the buyer of a call option exercises the option. In options ...
  3. Exercise Price

    The price at which the underlying security can be purchased (call ...
  4. Time Value

    The portion of an option's premium that is attributable to the ...
  5. Strike Price

    The price at which a specific derivative contract can be exercised. ...
  6. Moneyness

    A description of a derivative relating its strike price to the ...
RELATED FAQS
  1. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
  2. When is a call option considered to be "in the money"?

    Learn about call options, their intrinsic values and why a call option is in the money when the underlying stock price is ... Read Answer >>
  3. What happens when a security reaches its strike price?

    Learn more about the moneyness of stock options and what happens when the underlying security's price reaches the option ... Read Answer >>
  4. What is the difference between in the money and out of the money?

    Learn about how the difference between in the money and out of the money options is determined by the relationship between ... Read Answer >>
  5. How does the term 'in the money' describe the moneyness of an option?

    Find out what in the money means about the moneyness of call or put options and what it indicates about the relationship ... Read Answer >>
  6. When is a put option considered to be "in the money"?

    Learn about put options, what they are, how these financial derivatives operate and when put options are considered to be ... Read Answer >>
Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  5. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  6. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
Trading Center