Option Types, Positions, And Underlying Assets
A call (put) option gives the owner the right to purchase (sell) the underlying asset at a strike price. When the owner executes this right, the option is said to be exercised. Because long (buy, purchase) option positions give the owner the right to exercise, the seller (short, writer) of the option has the obligation to meet the terms of the option.
American options may be exercised at any time up to and including the contract’s expiration date, while European options can be exercised only on the contract’s expiration date. Exchange-traded options are typically American options.
Primary types of exchange-traded options include option on individual stocks, foreign currency, stock indices, and futures.
Option Specification And Trading
For a call (put), when the underlying asset price is less (greater) than the strike price, the option is said to be out of the money. For both a call and put, when the underlying asset price is equal to the strike price, the option is said to be at the money. For a call (put), when the underlying asset price is greater (less) than the strike price, the option is said to be in the money. Options are not adjusted for cash dividends, but are adjusted for stock splits.
LEAPS are options with expiration dates greater than a year. Nonstandard option products include FLEX options, ETF options, weekly options, binary options, CEBOs, and DOOM options.
Options with a maturity of nine months or fewer cannot be purchased on margin and must be paid in full due to the leverage effect of options. For options with longer maturities, investors can borrow up to 25% of the option value. Writers of options are required to have margin accounts with a broker.
Investors must account for commission costs when utilizing option. Commissions vary based on trade size and broker type. Commission rates typically are structured as a fixed dollar amount plus a percentage of the trade amount. In some instances, investors can earn higher profits by selling in-the-money options rather than exercising the options.
The Options Clearing Corporation (OCC) guarantees that buyers and sellers in the options market will honor their obligations and records all option positions. This minimizes default risk.
Warrants, employee stock options, and convertible bonds are option-like securities. Unlike options, these securities are issued by financial institutions or companies. The cost to the issuer of these securities is the possibility of increased dilution of the stock.
