Chapter 7: Options
Expiration Date
Options contracts exist for only a certain period of time. This is known as the expiration date. Options listed with longer expiration dates will have more time value since there is a greater chance of an option becoming in-the-money the longer there is for the underlying stock to move around. Option expiration dates are set according to a fixed schedule (known as an options cycle) and typically range from daily or weekly expirations to monthly and up to one year or more.
Strike Price
The strike price determines whether an option should be exercised. It is the price that a trader expects the stock to be above or below by the expiration date.
As an example, if a trader is betting that stock XYZ will rise in the future, they might buy a call for a specific month and a particular strike price. For example, a trader is betting that XYZ's stock will rise above $150 by the middle of January. They may then buy a January $150 call.
Contract Size
Contracts represent a specific number of underlying shares that a trader may be looking to buy. One contract is equal to 100 shares of the underlying stock.
Using the previous example, a trader decides to buy five call contracts. Now the trader would own five January $150 calls. If the stock rises above $150 by the expiration date, the trader would have the option to exercise or buy 500 shares of XYZ’s stock at $150, regardless of the current stock price. If the stock is worth less than $150, the options will expire worthless, and the trader would lose the entire amount spent to buy the options, also known as the premium.
Premium
The premium is the price paid for an option. It is determined by taking the price of the call and multiplying it by the number of contracts bought, then multiplying it by 100.
In our example, if a trader buys five January XYZ $150 Calls for $1 per contract, the trader would spend $500. However, if a trader wanted to bet the stock would fall they would buy the puts.