Stock Options

Stock Options are:
1. Standardized Contracts based on …
2. An Underlying Stock. It is …
3. A Derivative Product with
4. a Limited Life (has expiration date)

Stocks represent an investment in a real corporate entity. The value of the stocks are backed up by assets of a real company. These shares have an indefinite lifespan: they exist as long as the company exists.

Options are merely contracts. Options are Standardized contracts. Every stock option is standardized to control 100 shares of stock. This gives the stock option a leveraging effect.

The value of options depends on the price of the Underlying Stock. As such, stock options are Derivative products (as their price is derived from the underlying stock).

Stock options have a Limited Life. This makes them depreciating assets. They have to be exercised before a specific date (called the expiration date), after which they cease to exist.

In an option’s standardized contract, a third party called the OCC (Options Clearing Corporation) steps in:
• The buyer buys from the OCC, while ...
• The seller sells to the OCC ...
• The buyer and the seller does not deal directly with one another since …
• the OCC is their point of contact and contract.

The OCC is also the regulatory body which manages the option’s expiration date (the expiration date is usually set to expire on the third Friday of the month).

There are only 2 types of options:
(a) Call Options
(b) Put Options

For each option, we can only:
(a) Buy an Option, or
(b) Sell an Option.

As such, for each option, there are only 4 combinations:
(a) Buy Call
(b) Sell Call
(c) Buy Put
(d) Sell Put

  Next: Call Options ...