What is a Stock Option?

A Stock option is an option (otherwise known as a contract) to buy or sell a given stock at a selected price. Options have a strike price which is the price that the contract executes at. At this price you can either exercise your option or your right to buy or sell 100 shares of your stock at a given price. So, if you pay $100 for a call option with a strike price of $150 of ABC Company you can either buy the shares at $150 (per share x 100 = $15,000) or sell the stock option. If the current stock price is $155, you can sell your call option for approximately $500 so your trade would be highly profitable.

What is the Strike Price?

The strike price is the set price that the contract executes at, whether that be a sell or buy makes no difference, both calls and puts have a strike price. This is the price at which the underlying security will be bought or sold.

What is a Put option?

A Put option is an option to sell 100 shares of a given stock at a set “Strike Price”.

What is a Call Option?

A Call option is an option to buy 100 shares of a given stock at a set “Strike Price”.

Understanding the Greek Symbols in Options Trading:

What’s the Delta?

The delta is one of the Greek symbols associated with stock options. The delta shows a potential buyer or sell of a particular option the rate at which the option correlates to the underlying asset. For example, if you have a 0.70 delta on a particular stock option, you are looking at an option that will increase 70% for every increase of the underlying asset. So if the underlying asset increased by $1 ($1 x 100 = $100), the price of your stock option would have increased by $70. Moreover, the further in the money this option goes the more the delta will increase. Eventually as you get “further into the money” with a stock option there is typically less premium to sell since many consumers don’t want to pay premium for “Deep in the money” options.

What’s the Theta?

The theta of a stock option is the daily rate of decay at which the premium paid for a given stock option is lost. Options have a “time premium” built into their price, if they didn’t, then stocks and options would have a 100% correlation, which wouldn’t make sense. So, the Theta of a stock option is the rate at which the time premium decays. For example, if a stock option has a Theta of 0.10, that means that every day you hold this option you’re losing $10 (assuming the stock price remains unchanged). Therefore, it could be that after 10 days the time premium would completely decay and the contract would expire worthless (if it’s outside the money). The nearer the option is to expiration the less value that is held in time premium. This is why shorter dated options always cost less than longer time frame options of the same strike.

Inside the Money

In the money stock options are options that have intrinsic value to them besides just time premium. This means that if a stock option is nearing expiration and it has intrinsic value, your brokerage could potentially automatically exercise the stock option on you, unless stated otherwise.

Outside the Money

Outside the money stock options do not have any intrinsic value to them besides the time premium associated with the underlying contract. The closer to the money these assets go the more you can potentially lose.

Deep in the Money

These options typically have the least premium and although you are paying more per option, you are less likely to lose money on time premium and theta decay.

Stock options are a good hedge against your portfolio and this is one of the many reasons why consumers and companies chose to purchase buy stock options.