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Getting
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The Option
Contract, Holders and Writers
As
mentioned in the first lesson on this section, the option contract
gives the buyer or "holder" of the right, but not the
obligation to buy or sell shares of the underlying security at
a specified price on or before a given date. The holder of an option is not obligated to do anything
with the option once it has been purchased. You may be thinking that is fine for the holder but all
option contracts have two sides, what about the seller?
The
seller or option "writer" is obligated to perform
according to the terms of the option contract sold. In our example, the writer of the IBM November 100 calls is
obligated to sell 100 shares of IBM Corp. at $100 any time prior
to expiration if the option buyer chooses to evoke their right to
exercised. Similarly,
the writer of IBM November 100 puts is obligated to buy 100 shares
of IBM Corp. at $100 any time prior to expiration if the option is
exercised by the holder. The
writer must fulfill their end of the contract regardless of price. What does the writer get for this obligation? That's easy, the writer receives the premium paid by the
buyer. Regardless of
what happens to the underlying common stock, the writer gets to
keep the entire premium.
You
will note that we have tried to subtly introduce two new terms;
holder and writer. Let's
make this extra clear. The
holder is always the buyer of an option contract and the writer is
always the seller. It
makes good sense really, if you buy an option you get to hold it
and if you sell an option contract you get to write it.
About
now it is pretty easy to think that there are millions of
investors out there writing and buying innovative option contracts
but think again. All option contracts traded on U.S. securities
exchanges are issued, guaranteed and cleared by the Options
Clearing Corporation (OCC). That means they are standardized.
Now
let's take a closer look at the components of the option contract.
what is
an option 
option premium
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