IMPORTANT OPTION TRADING TERMINOLOGY

IMPORTANT OPTION TRADING TERMINOLOGIES.

Forget that there are hundreds of terms that the financial sector uses, all beginners hat to understand first are the most importand commonly used words.

OPTION : This is the right of the buyer to either buy or sell the underlying asset at a fixed price and fixed date. At the end of the contract, the owner of the option can choose to either buy or sell the option at the strike price. Though the owner has the right to pursue the contract he or she is not obligeated to do so.

CALL OPTION: The right to buy the underlying asset.

PUT OPTION : The right to sell the undeerlying asset

EXERCISE : The action where the owner has the choice to buy (if it is a call option) or sell (if it is a put option) the underlying asset or, to ignore the contract and let it expire. If the owner chooses to pursue the contract, they must send an exercise notice to the seller.

EXPIRATION: Is the date where the contract ends. If at expiration the owner does not exercise the rights, then the contract is terminated.

IN-THE-MONEY :  Where an option has an intrinsic value. If the underling asset is higher than the strike price, it is said to be in-the-money. Whereas a Put Option is in-the-money if the underlying asset is lower than the strike price.

OUT-OF-THE-MONEY: If an option is O-O-T-M it has no intrinsic value. The call option is out-of-the-money if the tradin price is lower than the strike price. The Put Option is out-of-the-money if the trading price is higher than the strike price.

OFFSETTING :  Is the act by which the owner of the option exercises his right to buy or sell the underelying asset any time before the end of the contract. This is done if the owner feels that the profitability of the stock has reached its peak within the date of the contract.

WRITER (Option Seller. The writer is the seller of the underlying asset or the option.

OPTION BUYER: Is the person who acquires the rights to convey the option.

STRIKE PRICE : This is the price at which you must sell the underlying stock if the contract is exercised. The strike price is always clearly stated in the contract. As the buyer of the option, to make a profit, the strike price must be lower than the current trading price of the stock.
An example.. if the contract states that the strike price of a certain stock is say $20 and the current trading price at the end of the contract is $25, the buyer can exercise his or her rights to pursue the contract, thus earning $5 per stock.

OPTION PREMIUM : The amount of the contract which must be paid by the buyer to the writer(or Seller). The option premium amount is determined by factors such as the type (call or put), the current strike price of the option, the volatility of the stock and very important, the time remaining until expiration and the price of the underlying asset to date. Taking all these factors into account, the total amount of the option premium is number of option contracts, multiplied by contract multiplier. Example, If you are buying 1 option contract (equivalent to 100 shares lots) at $2..5 per share, you must pay a total amount of $250 as the option premium. That is 1 option contract x 100 shares x$2.50 per share = $250

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