Option Basics Flashcards
Holder
Buyer of an option contract; holds the long position
Writer
Seller of an option contract; holds the short position
Call Option
Allows the holder to “call away” a security from the writer and buy it at a fixed price anytime within the lifetime of the contract
Put Option
Allows the holder to “put” a security to a writer, which obligates the writer to buy them at a fixed price
Strike Price
Price in the contract the option can be bought or sold for; also called the exercise price
Multiplier
Amount of the underlying security covered by the option
Multiplier for stock and interest rate indexes
100
Premium
Amount the holder pays the writer for the option; the market price of an option
Do longer or shorter contracts have higher premiums?
The longer the contract, the more likely the price will change to something beneficial, so their premiums are higher
Do securities with higher or lower price volatility have higher premiums?
Higher volatility means the price is more likely to move in the desired direction, so their premiums are higher
In the money (Call)
Market price is HIGHER than strike price
At the money (Call)
Market price is the SAME as the strike price
Out the money (Call)
Market price is LOWER than strike price
Time Premium
Amount of the premium that covers the remaining time on the option.
Total Premium - Intrinsic Value = Time Premium
Intrinsic Value
Amount of the premium that represents the difference between the strike price and the market price
Parity
When the premium = the intrinsic value
How does a high dividend rate affect call and put options?
Call: lower premiums because owning the security becomes more attractive
Put: higher premiums because owning a short position is less attractive
How does a high interest rate affect call and put options?
Call: higher premiums
Put: lower premiums
Open interest
the number of open contracts for a specific option
OCC
Options Clearing Corporation - keeps record of all options contracts
Opening Purchase
When the holder buys the contract
Closing Sale
When the holder trades the contract to someone else
Opening Sale
When the writer sells the contract
Closing Purchase
When the writer trades the contract
