4 Core Concepts…
Call Options, Put Options, Standard Options and Mini-Options
As stated in last week's article “How an Option is Similar to an Insurance Policy, ” the definition of an option is: “An option is a financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date)” as defined by Investopedia.com.
To continue our general discussion of options, today a few topics will be explored… the buying and selling of calls and puts, as well as the cost of a standard and a mini-option.
It may be helpful to refer to the article I published June 12, 2016, on assignment risk, something to consider when purchasing or selling options.
https://capitaldiscussions.com/assignment-in-options-trading-the-long-and-short-of-it/103212.
What is a Call Option?
A call option is a contract which will give the holder of the option the right to buy a stock, bond, commodity, or other instrument at a specific price for a defined fixed period of time.
Buying a Call Option…
When a call option is purchased the buyer has the right but not the obligation, to purchase 100 (only 10 with a mini contract) shares of stock at a specific price by a certain date. The buyer of the call option is considered long the option and considered long the position.
As a buyer you have rights. The right is to purchase 100 shares of the stock when you buy one contract. The buyer of a call contract can exercise the right to buy the underlying shares at the specified strike price for which he/she purchased the option.
Selling a Call Option…
When there is a buyer of an option you must have the opposite side of the trade. The opposite side of the trade is the seller of the option.
The seller of a call option has the obligation to sell 100 shares of stock at a specific price, when requested to do so, up till a specific period of time. The seller of the option collects a premium. When a call option is sold the seller is considered to be short the option and wants the price of the underlying to go down.
What is a Put Option?
A put option is a contract which will give the holder of the option the right to sell a stock, bond, commodity, or other instrument at a specific price for a defined fixed period of time.
Buying a Put Option…
The buyer of a put option has the right, but not the obligation to sell 100 (only 10 shares with a mini contract) shares of stock at a specific date by a certain time. The buyer of the put option is considered long the option. The buyer of the put is considered short the position.
Selling a Put Option…
The seller of a put option has the obligation to buy 100 (only 10 shares with a mini contract) shares of stock at a certain price, when requested, up till a specific time. The seller of a put option is considered to be short the put option. The seller of the put option is considered long the position.
Now let's discuss a Standard Option Contract…
As an investor when you buy a call option you essentially purchased a standardized right to buy a specific amount of an underlying asset at an agreed upon strike price.
A standard option contract is 100 shares of a stock. Therefore if you purchase one option contract it would equal 100 shares of stock. If you purchase two option contracts it would equal 200 shares of stock etc.. An option price quote is per share.
How to Determine the Cost of a Standard Option…
An important consideration before you trade an option is to have a full understanding of the cost the option you would like to buy or sell.
The total cost of an option is determined by the number of contracts times the $ per contract times 100 plus the commissions.
Here's an example…
10 contracts with a quote of $2.25 with $1.00 commission
(10 x $2.25 x 100) + (10 x $1.00 ) = 2250.00 + 10.00 = $ 2260.00
When you buy an option contract it has leverage because you are controlling 100 shares of stock. Many times it does not take much price movement to see substantial profits as well as possible losses.
What is a Mini-Options Contract?
Some popular mini-options are SPY, AAPL, AMZN, GLD, and GOOG.
A mini option contract consists of 10 shares of a stock. Therefore if you purchase one option contract it would equal 10 shares of stock. If you purchase two option contracts it would equal 20 shares of stock. An option price quote is per share. The commission quoted is per contract.
How to Determine the Cost of a Mini Option
The total cost of an mini option is determined by the number of contracts times the $ per contract times 10 plus the commissions.
Here's an example…
10 contracts with a quote of $2.25 with $1.00 commission
(10 x $2.25 x 10) + (10 x $1.00) = 225.00 + 10.00 = $ 235.00
As you can see it is quite easy to determine the cost of standard and mini-option contracts.
Now that you have a little more basic knowledge about puts, calls, standard and mini options you are one step further on your path to be a consistently profitable trader.
If you are interested in learning more about options trading in general, consider becoming part of the Capital Discussions community. There are classes, trade services, and numerous trading
groups where traders of all experience levels share their trades.
http://www.capitaldiscussions.com/join
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