Introduction: Options 101
Options are a leveraged way to invest in stocks. You get more bang for your buck.
It’s not quite as direct as just buying a stock, but the beauty is that options give you more flexibility and choice over the cost and timing. More on that shortly…
Simply put, a stock option is a contract that gives an investor the right (but not the obligation) to buy or sell shares of an underlying stock at a set price on or before a set date.
You can buy and sell options contracts on regular stocks, indexes, ETFs (exchange-traded funds), and futures contracts in the commodities world.
For example, if you wanted to play options on ExxonMobil Corp. (NYSE: XOM), XOM stock would be called the “underlying asset/security.”
When talking about stocks, each options contract is comprised of 100 regular shares of the underlying asset. For example, when you buy an option at $0.85, you are really paying $850 for options on 100 shares (one contract).
Okay, now let’s go over some basic terminology that you’ll need to know when executing trades…
Four Simple Terms of the Options Trade
No matter whether you’re buying or selling options, there are two main elements that make up every trade:
Strike Price: This is the set price at which your option is exercised — i.e. the target price of the underlying asset.
Expiration Date: This is the month and year that the option expires. If the right to buy or sell isn’t exercised by the expiration date, the option expires worthless. All options expire on the third Friday of the corresponding month.
The strike price and expiration date are fixed from the beginning of each options trade and don’t change for the duration of it.
For example, you would say, “Buy ExxonMobil January 25 calls.” Where ExxonMobil is the underlying security, the third Friday in January is the expiration date.
Puts and Calls
Just like you’d do when weighing up a stock trade, you have to decide whether you think the underlying asset is going to rise or fall. When playing options, there are two basic forms:
Call Options: You buy calls when you think the underlying asset is going to rise. These give buyers the right to buy the stock at the stated price on or before the stated date.
Put Options: You buy puts when you think the underlying asset is going to fall. These give buyers the right to sell the stock at the stated price on or before the stated date.
You can find a complete list of a company’s available call and put options at the various strike prices and expiration dates on its options chain.
These are available on the majority of financial sites. For example, on Yahoo! Finance, you put in the ticker of the underlying security and click “Enter.”
On the top left menu, it will say “Options.” Simply click that, and it will give you the put/calls chain with the various strike prices. There will be a drop-down menu to change the expiration date.
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Prices
Options prices are based on several factors, including strike price, expiration date, the volatility of the market, and the company and underlying asset in question.
The further out you go in time, the more expensive options are for the same strike price. Obviously, Microsoft has greater odds of hitting $65 next year rather than this Friday. You pay more for time.
The same goes for strike price: The farther away you are from “in the money,” the less you pay.
The more volatile a stock is, the more you will pay for the options.
And the more of a name brand the company is, the more you will pay for options.
So the next time you think oil will fall 40%, the market will become more volatile, or housing will jump — try an options play. A 5% one-week move in the underlying security could result in a 100% gain in your bank account.
Good hunting,
Christian DeHaemer
Check us out on YouTube!Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.
