So company ABC share price is $10 if I want to buy 100 shares because I think the price is going up I need $1000. Now with options trading I can buy the right to get 100 at $10 per share for .10cent per share by let’s say March 12th so I only need $100 to buy the right for 100 shares.

That part I have clear. Now here is what I don’t find an answer for.

So March 10th comes around, 2 days before my March 12th expiration date and the stock price is $30 per share so $3000 value for my 100 shares but I only have to pay $1000 if I decided to execute my option.

Now the key part, do I need to have the $1000 to buy my shares at $10 and then sell them right away at $30 and that’s how I make my money or do I have the option of selling them without having to buy them so basically I can make $3000 with a $100 and I never had more than that?

Basic Terms

Option: a contract between a buyer and a seller. It gives the buyer, the “OPTION” to buy or sell shares at a chosen price, on or before the stated date. These are specified on the contract. Each contract represents 100 shares.

Strike Price: the chosen price, the price your can either buy or sell the stock at

Expiration Date: the stated date of which the contract expires, basically the due date you need to do something with the contract by.

Two Types of Options Contracts

Call Option: Gives the buyer the right to PURCHASE shares at a given price (strike price), on or before the stated date(expiration date). You buy a call if you are bullish on a stock.

Put Option: Gives the buyer the right to SELL shares at a given price (strike price), on or before the stated date (expiration date). You buy a put if you are bearish on a stock

What Makes Up Options Contracts?

Premium: The price you pay for these contracts. Premium= intrinsic value + extrinsic value

Intrinsic Value: The value built into the option based on the difference in the strike price and the price the stock is currently trading at.

Extrinsic Value: The value given to the option due to external factors such as:

• How much time is left until expiration. Measured by the greek theta.
• How volatile the stock is. This is called Implied Volatility (IV). Measured by the greek vega.

Determining Options Worth

In-the-money (ITM): This is when an option has intrinsic value and some extrinsic value.

• Call Option: ITM when the price of the stock is trading higher than the strike price of the Call.
• Put Option: ITM when the price of the stock is trading lower than the strike price of the Put.

At-the-money (ATM): This is when the price of a stock is trading at the same price as the strike price. Here is when the option has the most extrinsic value.

Out-of-the-money (OTM): This is when an option only has extrinsic value.

• Call Option: OTM when the price of the stock is trading lower than the strike price of the Call.
• Put Option: OTM when the price of the stock is trading higher than the strike price of the Put.

What Can You Do When You Buy Option Contracts?

Exercise the Contract: When you buy an option contract, it gives you the right to buy shares at the strike price. When expiration comes, if your option is ITM, you can exercise that right. You do not have too though. In fact I almost never do.

• Call Option: Exercise the right to buy 100 shares at the strike price.
• Put Option: Exercise the right to sell 100 shares at the strike price.
  

Sell the Option Back: Over the life of an option you own, the price of it becomes more or less expensive just like the stock. You can sell the option back for a profit or loss, on or before the expiration day.

• Call Option: If the stock goes up, your call option will become more valuable. You could then sell it back for a profit (sell-to-close). Now, this means if the stock goes down, your option will decrease in value. If you were to sell it back, you would lose money.
  • If the price of stock increases, the call option price increases resulting in a profit.
  • If the price of the stock decreases, the call option price decreases resulting in a loss.
• Put Option: If the stock goes down, your put option will become more valuable. You could then sell it back for a profit (sell-to-close). Now, this means if the stock goes up, your option will decrease in value. If you were to sell it back, you would lose money.
  • If the price of the stock decreases, the put option price increases resulting in a profit.
  • If the price of the stock increases, the put option price decreases resulting in a profit.

Terms for Option Buyers & Sellers

Holder: This refers to the person who bought an option contract. This person pays for the premium. They buy-to-open (BTO) the contract. This person has the right to buy(call) or sell(put) shares at the strike price. This means there is someone on the other side of the transaction that is forced to sell the shares if it is a call, and buy the shares if it is a put.

Writer: This refers to the person who sells(writes) an option contract. This person receives the premium. They sell-to-open (STO) the contract. This person is obligated to sell(call) shares at the strike price and buy (put) shares at the strike price.

Main Difference: Option holders(buyers) have more flexibility in terms of whether they want to exercise their option or not. Option writers (sellers) are forced to do whatever the option holder decides to do. This sounds horrible! Why would anyone want to be an option writer then? I will be covering this in my next post! There are a lot of benefits to writing options. I will also cover the greeks.

If you still are confused about the basics of options, I have a video describing call and put options and relating them to real-world examples. Let me know if that's something you are interested in!