Stock Options

| December 8, 2011 | 0 Comments

A stock option is simply the right to buy or sell a specific stock at a certain price for a limited period of time.

The stock in question is known as the underlying security.  To explain stock options properly, we need some more information…

There are two basic types of stock options… a call option, and a put option.

A call option gives the holder the right to buy the underlying security.  And a put option gives the option holder the right to sell the underlying security.  These are the two types of stock options used in options trading.

When talking about options, we need to know the four components which uniquely describe any options contract.  We’ve identified the first above, either a put or a call.  Now let’s look at the rest.

The next part of the option identifies the underlying stock.  So if you are buying calls on Microsoft (MSFT), you’d be buying MSFT Calls.

The third component necessary to trade stock options is the exercise price.

The exercise price is the price at which the stock may be bought or sold.  It’s also known as the strike price.  In the options world, “exercise price”, and “strike price” are interchangeable.

As stated earlier, a stock option only affords this right to buy or sell for only a limited time.  This brings us to the fourth and final element of a stock option… the expiration date.

Of course, each option has its own unique expiration date.  Here’s how a basic stock options quote would be expressed…

X December 17 $20 Calls

Here’s how this easily translates…

When looking at this quote we can see we’re dealing with US Steel’s stock (X).  That’s step 1.

And it can be purchased on December 17th (expiration date).  This is step two.

For this option, the exercise price is going to be $20 dollars.  Remember, it’s also known as the “strike price”.

And last, we’re going to say if this is a Call or a Put option.  Since we’re choosing a Call, it means we will have the right to buy X at $20.  That means if US Steel (X) is trading for $22 per share on December 17th, and we own a $20 Call option on the stock… we can buy US Steel for $20.

That means we’ll be buying the stock for less than it’s currently trading!  And that’s one of the primary goals of buying a call option…

Category: Options Trading Basics

About the Author ()

Marcus Haber is the co-editor of Options Trading Research and boasts well over a decade of real-life options experience. Learning from some of the biggest names in the business, Marcus has served as an Options Strategist for a number of firms and was also appointed to the Options Advsiory Board with Pershing, a branch of the Bank of New York.