Options
What is an option?
An option is a contract that can be purchased to give you the ability to buy or sell 100 shares of a stock at a given "strike" price. Options are used to exercise that ability as well as traded based on premium price action. Options can carry far more risk and volatility than stocks and for that reason they are both not for beginners but can also be very profitable.
Types of options
The 2 most commonly used types of options are calls and puts.
Calls give you the ability to buy 100 shares of the stock you purchased the option for at the given strike price.
Puts give you the ability to sell 100 shares of the stock you purchased the option for at the given strike price.
Terms of an option contract
Here are some of the key terms revolving around options:
Premium - The price of your contract. This cost is not included with the purchase/sale of stocks if you choose to exercise your contract.
Strike Price - The "target" price of your contract. A $110 call for Apple has a "strike price" of $110.
Break Even - This is your Strike Price plus(call) or minus(put) your premium. This is the price the underlying stock will have to get to for you to break even on a given option, assuming you exercise the option.
Expiration Date - This is the date at which the contract expires. After that date you will either be assigned shares if you choose or lose the premium you paid for your contract.
In-the-Money - The stock price is above(call) or below(put) the strike price.
At-the-Money - The stock price is at the strike price.
Out-of-the-Money - The stock price is below(call) or above(put) the strike price.
Factors of an option's price
An option contract's price, or premium, has a lot more to it than 'it goes up or down with the stock.' Time, volatility of a stock, and more go into what people will pay for an option. Many people will buy and sell options without ever exercising them, and only play off of option's premiums.
For example: Apple's stock price is $105
If you have a $110 Apple call with an expiration date of tomorrow it will be worth close to nothing. However, if you have a $110 Apple call expiring in 2 months, it will still have value because of time.
Greeks - Greeks are variables used to compare an option's premium to time and the underlying stock. The main 4 are Delta, Gamma, Theta, and Vega.
Delta - Shows the rate of change in an option's premium compared to the underlying stock's price. The closer to 1, the more correlation between an option's premium and the stock price.
Gamma - Similar to Delta, however shows rate of change between an underlying stock price and Delta. The closer to 1, the more correlation between an underlying stock's value and Delta's value.
Theta - Shows the rate of change in an option's price and time. The value represents the change of price for every day until expiration.
Vega - Value representing the change in price given a 1% change in implied volatility. The more implied volatility of a stock, the more both call and put premiums will be.
