Options are mythical products. One of the reasons for this is the lingo. Let’s demystify this!
What does that mean?
It means that an option is not about one stock, it is about more than stocks. The contract size defines this. Most option contracts deal with 100 stock.
There are exceptions. Some Italian contracts deal with a contract size of 1000 or more.
When you buy a call, strike 50€, for a premium of 0,5€, you actually need to pay 0,5€ times 100. That makes 50€.
When you decide to exercise your call (that is, you wan to to buy the stock for strike), you actually buy 100 stock. In this case, this will cost you 5000€
With stock, you simply buy or sell. With options, it is a little more complex.
When you want to buy an option, you do a buy-to-open. This means that you buy the option and open your position. For this, you pay a premium. In your broker screen, you now will see that you own the option and see a +1 next to the position. Your cash account shows an outgoing payment (the option premium and the trading fee)
When you now want to sell this option, you sell-to-close. You get a premium for this. Your cash account receives money. (the premium from selling minus the trading costs)
Other possibilities are
- Sell-to-open: you sell a contract to be on the other side. You have no right, you now have obligations. You get a premium for this.
- Buy-to-close: you want to close a postion and end your obligations. You have to pay a premium for this.
More and more brokers start to simplify and show you buy or sell. They will calculate themselves if it is a buy-to-open or sell-to-close or any other possibility.
Options have an expiration date. Usually this is a Friday. Just make sure you know the date your option expires.
There are friendly brokers out there that will email you a few days in advance to inform you of upcoming expirations.
Good to know
Options that expire on the 3rd Friday of the month are called the Monthly options. These options are used more than the other dates. They are often more liquid. the other series are called the weeklies.
All sort of exotic variants are possible. Keep an eye on the expiration date. It can be the difference between a profit and a loss.
European style vs american style
As the owner (buyer) of an AMERICAN style option, you have the right to exercise your option any day before the expiration date. Whenever you feel there is enough profit in the option, you can exercise it. No questions asked.
When I own an american style put on stock ABC, strike 50, expiration 18-03, I can sell my stock whenever I want at 50. So, on 18-02, when they trade 45 on the open market, I can still sell them at 50. That is why I paid a premium.
Most options on stock and ETFs are American Style.
There are also EUROPEAN style options. These can only be exercised during a specific timeslot on the expiration day. That means, on 18-02, you can not sell you stock for 50. You can however sell the option and offset the loss this way.