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Options 101
The CBOE {Chicago Board Options Exchange} is the biggest options exchange in the world. Options are available for more than just stocks. Options can be traded on world currencies, treasuries, stock indexes, interest rates and commodities such as oil and gold. The companies that own the stock do not offer options. They are contracts to buy or sell stocks written buy option writers. Owners of "call" options have no stock owner rights such as voting or dividends. The first advantage of option investing is that you can bet on a stock to go down without having to open a margin account. Most margin accounts require $25,000 or more to start. What's worse, your margin may be called. This means you have to buy the stock that you sold short. Margin accounts are very scary for investors who don't have a lot of money to play with. Most option contracts are equivalent to 100 shares of stock. If you buy 10 contracts, you hold the equivalent of 1000 shares of stock. GLOSSARY: American-style option: An option that can be exercised at any time prior to its expiration date. ask / ask price: The price at which a seller is offering to sell an option or a stock. Black-Scholes formula: The first widely-used model for option pricing. This formula can be used to calculate a theoretical value for an option using current stock prices, expected dividends, the option's strike price, expected interest rates, time to expiration and expected stock volatility. While the Black-Scholes model does not perfectly describe real-world options markets, it is still often used in the valuation and trading of options. Call option: An option contract that gives the owner the right to buy the underlying stock at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a Call option, the contract represents an obligation to sell the underlying stock if the option is assigned. contract size: The amount of the underlying asset covered by the option contract. This is 100 shares for one equity option unless adjusted for a special event, such as a stock split or a stock dividend. expiration cycle: The expiration dates applicable to the different series of
options. Traditionally, there were three cycles: Today, equity options expire on a hybrid cycle which involves a total of four option series: the two nearest-term calendar months and the next two months from the traditional cycle to which that class of options has been assigned. For example, on January 1, a stock in the January cycle will be trading options expiring in these months: January, February, April, and July. After the January expiration, the months outstanding will be February, March, April and July. fundamental analysis: A method of predicting stock prices based on the study of earnings, sales, dividends, and so on. good-'til-cancelled (GTC) order: A type of limit order that remains in effect until it is either executed (filled) or cancelled, as opposed to a day order, which expires if not executed by the end of the trading day. A GTC option order is an order which if not executed will be automatically cancelled at the option's expiration. LEAPS (Long-term Equity AnticiPation Securities also known as long-dated options) In English, this means Calls and Puts with an expiration as long as thirty-nine months. Currently, equity LEAPS have two series at any time with a January expiration. leverage: A term describing the greater percentage of profit or loss potential when a given amount of money controls a security with a much larger face value. For example, a Call option enables the owner to assume the upside potential of 100 shares of stock by investing a much smaller amount than that required to buy the stock. If the stock increases by 10 percent, for example, the option might double in value. Conversely, a 10 percent stock price decline might result in the total loss of the purchase price of the option. option: A contract that gives the owner the right, but not the obligation, to buy or sell a particular asset (the underlying stock) at a fixed price (the strike price) for a specific period of time (until expiration) . The contract also obligates the writer to meet the terms of delivery if the contract right is exercised by the owner. Put option: An option contract that gives the owner the right to sell the underlying stock at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a Put option, the contract represents an obligation to buy the underlying stock from the option owner if the option is assigned. technical analysis: A method of predicting future stock price movements based on the study of historical market data such as (among others) the prices themselves, trading volume, open interest, the relation of advancing issues to declining issues, and short selling volume. A very good web site to visit about options is http://www.cboe.com/ |
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