Options are contracts based on underlying securities like stocks, commodities, bonds etcetera. Options give the holder the right to buy or sell a security at a specified price during a designated period of time. This can mostly in months to a bit more than a year for the stocks. Recently Euronext also introduced options with a maturity of only one week. So there’s a very big variety of periods available.
Call options give the owner the right to purchase a given number of shares and put options have the right to sell a given number of shares. Big option exchanges in the world are the CBOE (Chicago Board Options Exchange) and the Euronext (or NYSE Euronext in the past). Options were originally invented by the Dutch in Amsterdam who seeked for ways of hedging investments.
Options offer a range of investment alternatives from very speculative to very conservative.
With this short introduction video about options we explain the most important features of them.
Every option has the following items: the exercise price, the expiration date and it’s type (either a put option or a call option). The exercise price (or strike price) is the price on which the option will be settled on the expiration date. Exercise prices are normally quite near a stock’s current price but can also be way low or way higher. This very much depends on the liquidity of the underlying stocks. As an example, if the stock is currently selling for 38 euros per share, the option may specify a strike price of 40 euros. This means that the holder of the option can buy the stock for 40 euros per share for the duration of the option.
The expiration date is the date on which the option expires. This is always on the 3rd Friday of the certain month.
As option contracts are depend on the underlying stocks a relatively high volume of trading in the underlying stock is essential. This implicates that only the stocks with the highest trading volumes have options outstanding. These are mostly the large and midcap stocks.
Now we going to talk about moneyness of the options. The moneyness tells us if the price of the stock is in range of the price of the option. The moneyness is divided in three types: in the money, at the money and out of the money.
An in the money call option is an option with a market price of the stock that is in excess of the exercise price for the call option. For put options it’s vice versa: a put option is in the money in case the market price of the stock is below the exercise price.
When the market price of the stock is equal to the exercise price then for both call and put options the option is call at the money.
An out the money call option is an option with an exercise price higher than the current market price of the stock. And for put options is also vice versa: a put option is called out of the money in case the market price of the option is lower than the exercise price.
In other videos we elaborate more the strategies that could be done with options.
Video done by Denise Lindemann and Tim van Thienen.