An option is a choice. If you buy a call or put option, you can choose to either buy or sell a stock at a specific price for a pre-determined period of time. The price is known as the strike price. The life of an options contract is determined by the expiration date. After the option expires, it no longer exists. Each contract can be defined by its underlying security, the strike price of the option, and the expiration date. Options can be used to speculate or to hedge I have helped investors do a little of both using options. The industry is growing and options volumes continue to set records. Yet, many people still don’t know how to get started or are still wondering, “What’s an option?” Here are a few questions and answers designed to help makes sense of the options product.
What’s the difference between a put and a call? Both are options contracts or agreements between two parties. If I buy an Intel (INTC) January 20 call option at $0.90 per contract, I have purchased the right to buy 100 shares at $20.00 each. I can exercise my contract and buy the stock through the third Friday of January (before the options expire on Saturday, January 22). The stock is at $20.68 and so if Intel shares rally 6.4% to $22.00, I can exercise my call and buy the stock at $20, sell it in the market for $20.00, and make $2.00 per share profit (minus the $0.90 paid for the calls). An Intel January 20 put, on the other hand, gives me the right to sell 100 shares at $20.00 through the January 22 options expiration.
Who sells options? Anybody can sell an options contract, provided their brokerage firm allows them too. In fact, for every options buyer, there’s a seller. In fact, some traders prefer to sell options rather than buy them because of time decay. Since options contracts expire on specific days, the contracts lose value over time. The seller or “writer” of an options contract is taking on the obligation to buy (for puts) or sell (for calls) the stock during the life of an options contract. For example, if I sell an Intel January 20 put at $0.90, I’m on the hook to buy the stock at $20.00 no matter what happens. If the stock falls to $10.00, I would be asked to buy it at $20.00. If so, I have been assigned on the contract and there is nothing I can do. When a call writer is assigned, they are asked to sell the underlying stock – 100 shares for every call option.
If an options contract is an agreement between two parties, what if I can’t find someone to take the other side of the trade? Don’t worry about it. If there is a quote for an options contract, the market maker fulfills the role of executing the trade. You enter the order with your broker and that’s all you really need to worry about.
How do I find options quotes? Your brokerage firm can provide options quotes, but many other web sites offer them as well. The easiest way to view options prices is with an options chain.
