The definition of stock options is simple. They are contracts between different parties where the buyer purchases the right, rather than the obligation, to buy or sell shares of underlying stock at a preset price to or from an option buyer or seller within a certain time. Here, readers can learn some of the terms specified in options contracts.

Option Types

There are a couple of kinds of stock options: puts and calls. The call option gives a buyer rights to buy an underlying stock, while the put option gives them the right to sell the stock.

Strike Pricing

A strike price is a price at which an underlying asset is to be sold or bought when the owner exercises his or her option. Its relation to the asset’s market value affects the viability of the action, and it can be a major determinant of premiums.

Premium

In return for the rights given by the stock option, the buyer has to pay the seller a premium for taking on the risk that accompanies the obligation. The premium depends on the strike pricing, volatility of the asset, and the time remaining until the option’s expiration.

Expiration Dates

Stock option contracts are depreciating assets, and they expire after a certain time. Once the option has expired, the right to exercise it is no longer existent and the option is worthless. The expiration date is specified in each contract, and the specific date depends on the option type. For instance, a stock option listed in the U.S. expires on the third Friday of the month of expiration.

Style

Option contracts are available in either an American or a European style. The manner in which these options are exercised depends on the style. An American option can be exercised any time prior to expiration, while a European-style option is only exercised on its expiration date. All of the options currently traded in the marketplace are American-style options.

Underlying Assets

An underlying asset is a security which the option seller has the requirement to deliver to or buy from an option holder in the event the option is fully exercised. In the case of a stock option, an underlying asset is a share of a specific corporation. Options can also be bought for other kinds of securities such as indices, currencies, and commodities.

A Beginner’s Guide to Options Trading