Option Trading for Rookies, Session I:
Option Trading Terminology
Disclaimers
Options involve risks and are not suitable for all investors. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options, sent to you in previous communication. Additional copies
may be obtained by calling TRADEKING at (877) 495-KING visiting
www.tradeking.com/ODDor by downloading the file from the recourses tab on your screen.
System response and access times may vary due to market conditions, system performance, and other factors. Margin trading involves risks and is not suitable for all accounts.
Market timing is a complex investment strategy which involves risk and may incur additional commission costs.
Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax advisor as need.
All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns.
3
Disclaimers
Any strategies discussed and examples using actual securities and price data are strictly for illustrative and educational purposes only and are not to be construed as a recommendation, or solicitation to buy or sell securities.
Consider the following when making an investment decision: your financial situation, your risk profile and transaction costs. You alone are responsible for evaluating the merits and risks associated with the use of TradeKing’s systems, services or products.
The projections or other information generated by TradeKing's tools regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.
© 2014 TradeKing Group, Inc. All rights reserved.
Securities offered through TradeKing, LLC, member of FINRAand SIPC.
Option Trading for Rookies, Session I:
Option Trading Terminology
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 5 Options are contracts:
Giving the owner the right to buy or sell an asset at a fixed price for a specific period of time
And, obligating the seller to take the opposite side if and when the right embedded in the option contract is
exercised by the owner.
What Are Options?
Examples
XYZ January 70 Call at $3.10
ABC February 35 Put at $1.20
Calls are options to buy a stock.
– The buyer obtains the right (but not the obligation) to purchase the underlying stock.
Puts are options to sell a stock.
– The buyer obtains the right (but not the obligation) to sell the underlying stock.
Call or Put
Examples
XYZ January 70 Call at $3.10
ABC February 35 Put at $1.20
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 7 Long – Implies you bought an option contract.
– When you’re talking about options and stocks, “long” implies a position of ownership. After you have purchased an option or a stock, you are considered "long" that security in your account.
Short – Implies you sold an option contract that you didn’t own.
– If you’ve sold an option or a stock without actually owning it, you are then considered to be “short” that security in your account.
Long or Short
Examples
Bought – Long XYZ January 70 Call at $3.10
Sold – Short ABC February 35 Put at $1.20
Options are customarily on one underlying.
Stock options ordinarily represent 100 shares of the underlying stock.
– Exceptions to the norm are usually caused by corporate actions and stock splits.
Underlying
Examples
XYZ January 70 Call at $3.10
ABC February 35 Put at $1.20
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 9 The pre-determined price at which the underlying asset
will be bought or sold should the option be exercised.
In the listed options marketplace the strike prices are standardized.
– Stocks priced between 0 – 25, intervals of 2 1/2
– Stocks priced between 25 – 200, intervals of 5
– Stocks priced greater than 200, intervals of 10
• Many exceptions to these guidelines.
Strike Price
Examples
XYZ January 70 Call at $3.10
ABC February 35 Put at $1.20
The price of the option.
Paid by buyer; received by seller.
The price is multiplied by the number of shares the contract represents, generally 100 shares.
$3.10 option actually costs 100 x 3.10 or $310
Premium
Examples
XYZ January 70 Call at $3.10
ABC February 35 Put at $1.20
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 11 Stock options can be exercised on any business day up
to expiration
Usually American-style stock options expire on the Saturday following the third Friday of each month.
– Some exceptions to this rule also.
The last day they can be exercised or traded is the third Friday of the month.
PM Settlement.
Expirations – American Style
Examples
XYZ January 70 Call at $3.10
ABC February 35 Put at $1.20
Exercise:
to invoke the right contained in an option contract Assignment:
to be required to fulfill the obligation
Exercise & Assignment Defined
Buyers pay cash and receive a benefit The ability to exercise
Sellers receive cash and have a obligation May be assigned
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 13
Right to
buy
Right to
sell
CALL
PUT
Obligation
to buy
Obligation
to sell
Buyer
(long)
Seller
(short)
Four Basic Positions
In’s and Out’s for Call Options
60 Strike Call Option Stock Price
50
55
6065
70
In-The-Money
Out-Of -The-Money
At-The-Money
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 15 Calls:
If I exercised the call first and then sold stock at the market, would I get anything?
In- At- or Out-of-the-money?
Question:
Stock at 23 on expiration, Currently - Long 20 Call, this option is considered…. a) ITM
b) OTM
Get $3 per share.
In’s and Out’s for Put Options
80 Strike Put Option Stock Price
At-The-Money
In-The-Money
Out-Of-The-Money
70
75
8085
90
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 17 Puts:
If I bought stock at the market first and then exercised the put, would I get anything?
In- At- or Out-of-the-money?
Question:
Stock at 74 on expiration, Currently - Long 75 Put, this option is considered…. a) ITM
b) OTM
Puts:
If I bought stock at the market first and then exercised the put, would I get anything?
In- At- or Out-of-the-money?
Question:
Stock at 74 on expiration, Currently - Long 75 Put, this option is considered…. a) ITM
b) OTM
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 19 Stock Price 36
Strike Price - 30 Intrinsic Value 6
Intrinsic & Time Value
Options Price 7 Intrinsic Value - 6 Time Value 1 30 Strike Call @ 7 Stock Price @ 36
Intrinsic & Time Value
Stock Price ? Strike Price - ? Intrinsic Value ? Options Price 2.00 Intrinsic Value - ? Time Value ? 30 Strike Call @ 7 Stock Price @ 36 2.00 35
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 21 Option Volume
– Option volume is the number of option contracts that have traded within a day.
Open Interest
– Open interest is the number of outstanding option contracts of a particular strike price and expiration date that have been bought or sold to open a position. An opening transaction increases open interest and a closing transaction decreases it. Open interest is calculated at the end of each business day.
Volume and Option Interest
Examples
XYZ January 70 Call at $3.10
ABC February 35 Put at $1.20
Sell to close or buy to close
Exercise or accept assignment - Shares are exchanged at the
pre-determined price (strike)
Let expire (worthless)
Audio Help: 866-569-3239 Speakers: M. Kahn
and B. Overby
Speaker: Brian Overby Audio Help: 866.229.3239 23 There are quite a few differences between options based on an
index versus those based on stocks.
– First, index options typically can’t be exercised prior to expiration, whereas stock options typically can.
– Second, the last day to trade most index options is usually the Thursday before the third Friday of the expiration month. But the last day to trade stock options is the third Friday of the expiration month.
– Third, index options are cash-settled, but stock options result in stock changing hands.
Note: There are several exceptions to these general guidelines about index options. If you’re going to trade an index, you must take the time to understand the option contract characteristics.
Index Options vs. Stock Options
Option Trading for Rookies Next Session
An Introduction to Option Pricing
Thursday, November 13th
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To learn more about option strategies:
Option Trading for Rookies, Session I:
Option Trading Terminology
Homework
Option Mechanics I
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 47 _ _ _ Long 1 50 Call 116 _ _ _ Long 1 120 Put 88 _ _ _ Long 1 90 CallOption Mechanics I
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 47 _ _ _ Long 1 50 Call 116 _ _ _ Long 1 120 Put 88 _ _ _ Long 1 90 Call Expires 0-Option Mechanics I
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 47 _ _ _ Long 1 50 Call 116 _ _ _ Long 1 120 Put 88 _ _ _ Long 1 90 CallOption Mechanics I
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 47 _ _ _ Long 1 50 Call 116 _ _ _ Long 1 120 Put 88 _ _ _ Long 1 90 CallOption Mechanics I
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 47 _ _ _ Long 1 50 Call 116 _ _ _ Long 1 120 Put 88 _ _ _ Long 1 90 CallOption Mechanics I
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 47 _ _ _ Long 1 50 Call 116 _ _ _ Long 1 120 Put 88 _ _ _ Long 1 90 CallOption Mechanics II
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 71 Long 300 Shares Short 3 65 Calls 34 _ _ _ Long 1 25 Put 42 _ _ _ Long 1 40 CallOption Mechanics II
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 71 Long 300 Shares Short 3 65 Calls 34 _ _ _ Long 1 25 Put 42 _ _ _ Long 1 40 Call Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 71 Long 300 Shares Short 3 65 Calls 34 _ _ _ Long 1 25 Put 42 _ _ _ Long 1 40 CallOption Mechanics II
Option Mechanics II
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 71 Long 300 Shares Short 3 65 Calls 34 _ _ _ Long 1 25 Put 42 _ _ _ Long 1 40 CallOption Mechanics II
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 71 Long 300 Shares Short 3 65 Calls 34 _ _ _ Long 1 25 Put 42 _ _ _ Long 1 40 CallOption Mechanics II
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 71 Long 300 Shares Short 3 65 Calls 34 _ _ _ Long 1 25 Put 42 _ _ _ Long 1 40 CallOption Mechanics III
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 46 _ _ _ Long 5 40 Calls & Short 5 50 Calls
Option Mechanics III
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 46 _ _ _ Long 5 40 Calls & Short 5 50 CallsOption Mechanics III
Stock @ Exp. Stock Position Option Position Exercise Assigned Expires Ending Position (long, short cash, zero) 46 _ _ _ Long 5 40 Calls & Short 5 50 Calls