Stock options are options that are based upon individual stocks (such as Sony or Phillips), known as the underlying stock (or simply the underlying). Stock options give the right (for the buyer) or potential obligation (for the seller), to buy or sell the underlying stock at a specific price, either on (for European style options), or before (for US style options) a specific date (known as the expiration date).
Stock options are available for most individual stocks that are traded in the US, Europe, or Asia, and are offered by futures exchanges (such as the DTB in Europe) or options exchanges (such as the Chicago Board Options Exchange in the US). However, once again, the US SEC (Securities and Exchange Commission) has implemented restrictions that prevent US traders from trading non US stock options, so US traders can only trade US stock options.
Stock Options Contracts
Stock options markets trade stock options contracts, with 1 contract being the smallest unit that can be traded. Stock options contracts also detail all of the information that is needed to trade a particular stock option, such as the following information (for Whole Foods Market):
- Symbol : WFMI
- Currency : USD
- Exchange : AMEX, CBOE, etc.
- Multiplier : 100
- Expiration date : December 22nd 2007
- Last trading date : December 21st 2007
- Strike price : 45
- Type : Call or Put
- Exercise style : US (exercise at any time before expiration)
- Minimum size : 1 contract
- Tick size (minimum price change) : $0.05
Most of the information in an options contract is the same as any other day trading market (such as the currency), but some of the information is specific to stock options markets.
Multiplier - The multiplier specifies the number of shares of the underlying stock are included in the options contract. For most stock options this is 100 shares.
Strike price - The strike price is the price at which the underlying shares will be bought or sold if the option is exercised.
Type - The type of option determines whether the buyer has the option to buy the underlying shares, or sell the underlying shares. If the option type is a call, the buyer has the right to buy the underlying shares, and if the option type is a put, the buyer has the right to sell the underlying shares.
Exercise style - The exercise style is either US or European, but this has nothing to do with the country of origin. US style options can be exercised at any time before they expire, while European style options can only be exercised on expiration day.
Rights and Obligations
Stock options either give the right to buy or sell the underlying stock, or they have the potential obligation to buy or sell the underlying stock. The following table explains the rights and obligations associated with the different types of options, and the different sides of the transaction (buyer or seller) :
- Buyer
- Call - The right to buy the underlying stock
- Put - The right to sell the underlying stock
- Seller
- Call - The potential obligation to sell the underlying stock
- Put - The potential obligation to buy the underlying stock
The reason that the seller's obligation is only a potential obligation, is because their options may or may not be exercised, and if they are exercised, the seller may or may not be assigned by the options clearing system (which uses a random method of choosing sellers).
Long Term Stock Options (LEAPS)
Standard stock options are relatively short term options which expire approximately every 3 months. Long term options are known as LEAPS (Long Term Equity Anticipation Securities), and they expire anywhere from 9 to 30 months. LEAPS are very useful for long term trades, or for protecting profit from an already existing trade (such as a long term stock trade). Other than the different expiration lengths, LEAPS are the same as standard stock options, and are traded in exactly the same way.
