Stock Option Trading Basics
Posted August 20, 2010 – 5:52 pm in: UncategorizedFor those that are just starting out in learning how to trade options or trying to understand what options is, here is a list of explanations of what some of the most popular technical terms you will come across later in your trading career.
Call option is a financial contract between two parties, the buyer and the seller of this type of option. It is the option to buy shares of a stock at a specified time in the future.
The buyer of the option has the right, but not the obligation to buy an agreed quantity of a particular stock from the seller of the option at a certain time (the expiration date) for a certain price (the strike price).
However, the seller (or “writer”) is obligated to sell the stock should the buyer decides to exercise his/her right on the option. The buyer pays a fee (called a premium) for this right.
Put option is a financial contract between two parties, the seller (writer) and the buyer of the option. The buyer acquires a short position with the right, but not the obligation, to sell the stock at an agreed-upon price (the strike price). If the buyer exercises his right to sell the option, the seller is obliged to buy it at the strike price. In exchange for selling his/her stock to the buyer, the buyer pays the writer a fee (the option premium).
Strike price, also referred to as exercise price is the price at which the owner of an option can purchase, in the case of a call, or sell, in the case of a put, the underlying stock. It’s the price at which the stock will be bought or sold when the option is exercised.
Premium is the price that buyer pays the seller for carrying the risk for the obligation. This is similar to insurance premium where you pay the insurance company a premium, so in case if anything happens, the insurance company is obligated to compensate the damage. The price of the premium depends on many different factors such as strike price, time left until expiration date, interest rate, volatility, etc.
Expiration Date – Options is a wasting asset, meaning that it loses value as time goes by. Once the option expires, the option no longer has any value and become worthless. The expiration date is found in each option contract when it is bought.
American Style and European Style Option – There are two different types of options. American style option is one where buyers can choose to exercise the option any time up until the expiration date whereas the European style option is where buyers can only exercise on the expiration date.
These are just some of the most common terms you will come across when starting out in option trading. If you are serious about learning how to trade options, then you should adhere to some of the common option trading tips that every option trader would abide by..
Learning to trade options successfully begins with knowing your trading style and finding the right trading system to fit your style – http://howtotradeoptionsguide.com