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Getting
Started in Options
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What is an
Option?
First
things first, what is an option? In a nutshell, an option is a contract that gives the
holder 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. If that
sounds like something your family lawyer might have written don't
fret, we promise it is really very simple – and you won't have
to worry about that surprise bill in the mail.
Despite
what you might hear, there are only two types of options, calls
and puts. A call option gives its holder of the contract the right
to buy an underlying security, whereas a put option gives the
holder the right to sell an underlying security at a given price
on or before a given date. Simple enough so far, right? --let's make things even more
clear.
Consider
this example, International Business Machines (IBM) is trading at
$100. One
American-style IBM Corp. November 100 call sells for $2 and
entitles the holder to purchase 100 shares of IBM Corp. common
stock at $100 per share at any time prior to the option's
expiration date in November. Similarly, one American-style IBM Corp. November 100 put
sells for $2 and would entitle the holder to sell 100 shares of IBM
Corp. common stock at $100 per share at any time prior to the
option's expiration in November.
In
our example the option style is American (more on that later), the
underlying security is IBM Corp., the strike price is 100, the
expiration date is November, the unit of trade is 100 shares and
the option premium is $2. All
of these components are defined by the option contract. To understand options, it is important that you understand
the contract, what it implies and the significance of each
component.
an
introduction to options 
the option contract
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