Investor Bulletin: An Introduction to Options

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Company Filings More Search Options. Options trading may occur in a variety of securities marketplaces and may involve a wide range of financial products, from stocks to foreign currencies. This bulletin focuses on the basics of trading listed stock options.

Options trading uses terminology that an investor should understand before attempting to buy or sell options. The following example of a basic stock option contract quote will help explain some of this terminology:. This date indicates the day that the option contract expires. Generally, the expiration date for an option contract is the Saturday after the third Friday of each month.

However, certain option contracts may have an expiration date that occurs after only a week, a calendar quarter, or at other some other specified time. Two of the most common types of option contracts are calls and puts. A call option is a contract that gives the buyer the right to buy shares of an underlying stock at the strike price discussed below for a specified period of time.

Conversely, the seller of the call option is obligated to sell those shares to the buyer of the call option who exercises his or her option to buy on or before the expiration date.

A put option is a contract that gives the buyer the right to sell shares of an underlying stock at the strike price for a specified period of time. Conversely, the seller of the put option is obligated to buy those shares from the buyer of the put option who exercises his or her option to sell on or before the expiration date. This is the price at which the buyer of the option contract may buy the underlying stock, if the option contract is a call, or sell the underlying stock, if the option contract is a put.

Example in-the-money call option: Example out-of-the-money call option: An option contract generally represents shares of the underlying stock. The premium is paid up front to the seller of the option contract and is non-refundable. The amount of the premium is determined by several factors including: In addition to the terms above, investors should also be familiar with the following options terminology:. Assignment — When a buyer exercises his or her right under an option contract, the seller of the option contract receives a notice called an assignment notifying the seller that he or she must fulfill the obligation to buy or sell the underlying stock at the strike price.

Market Participants — There are generally four types of market participants in options trading: Opening a Position — When you buy or write a new options contract, you are establishing an open position. That means that you have established one side of an options contract and will be matched with a buyer or seller on the other side of the contract.

Closing a Position — If you already hold an options contract or have written one, but want to get out of the contract, you can close your position, which means either selling the same option you bought if you are a holderor buying the same option contract you sold if you are a writer. Now that we have discussed some of the basics of options trading, the following are examples of basic call and put option transactions:.

These two examples provide you with a basic idea of how options transactions may operate. Investors should note that these examples are some of the most basic forms of options.

Many options contracts and the trading strategies that utilize them are much more complex. The Additional Resources section below provides a hyperlink to additional publications you may review if you are interested in information on more complex options contracts and trading strategies.

Options like other securities carry no guarantees, and investors should be aware that it is possible to lose all of your initial investment, and sometimes more. Option holders risk the entire amount of the premium paid to purchase the option. Option writers may carry an even higher level of risk since certain types of options contracts can expose writers to unlimited potential losses.

Market Risk — Extreme market volatility near an expiration date could cause price changes that result in the option expiring worthless. Underlying Asset Risk — Since options derive their value from an underlying asset, which may be a stock or securities index, any risk factors that impact the price of the underlying asset will also indirectly impact the price and value of the option.

This bulletin has provided a brief and basic introduction to options for investors considering the use of options in their investment portfolio. For additional and more detailed information on options and the options marketplace, investors should consider reviewing the following:. Securities and Exchange Commission. Investor Alerts and Bulletins. Options are contracts giving the owner the right to buy or sell an underlying asset, at a fixed price, on or before a specified future date.

Options are derivatives they derive their value from their underlying assets. The underlying assets can include, among other things, stocks, stock indexes, exchange traded funds, fixed income products, foreign currencies, or commodities.

Option contracts trade in various securities marketplaces between a variety of market participants, including institutional investors, professional traders, and individual investors.

Options trades can be for a single contract or for several contracts. Basic Options Terminology Options trading uses terminology that an investor should understand before attempting to buy or sell options. The following example of a basic stock option contract quote will help explain some of this terminology: A call option is in-the-money if the strike price is below the actual stock price; A put option is in-the-money if the strike price is above the actual stock price.

A call option is out-of-the-money if the strike price is above the actual stock price; A put option is out-of-the-money if the strike price is below the actual stock price. In addition to the terms above, investors should also be familiar with the following options terminology: Options Trading Market Participants — There are generally four types of market participants in options trading: Now that we have discussed some of the basics of options trading, the following are examples of basic call and put option transactions: Now, suppose you believe the price of the stock will continue rising until the expiration date and you decide to wait to sell or exercise the option.

Now, suppose you believe the price of the stock will continue dropping up until the expiration date and you decide to wait to sell or exercise the option.

What are some of the risks associated with trading options? Other risks associated with trading options include: Additional Resources This bulletin has provided a brief and basic introduction to options for investors considering the use of options in their investment portfolio. For additional and more detailed information on options and the options marketplace, investors should consider reviewing the following:

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