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Understanding options - 11 Basics You Should Know

  1. An option is a security. You can buy or sell an option similar to buying or selling shares of stock.

  2. Options are considered derivatives because their value is “derived” from an underlying asset or security.

  3. There are options on many underlying assets including stocks, ETFs, indexes, currencies, and futures to name a few.

  4. There are only two types of options, calls and puts. You can buy or sell a call or put or do a combination of the two creating a spread.

  5. Call options represent the right (but not the obligation) to buy the underlying asset. This allows you to “call” the underlying stock away from the seller of the option.

  6. Put options represent the right (but not the obligation) to sell the underlying asset. This allows you to “put” the stock to the seller of the put.

  7. Options have a limited life. They are created with a known last day of life. This last day is their expiration day (A.K.A. the expiry) and the contracts can be traded up until then.

  8. Every option has a strike price. This is the price of the underlying asset that that applies when the option’s owner exercises the contract.

  9. The value of an option consists of intrinsic value and time value.

  10. Intrinsic value is the difference between the strike price and current market price of the underlying. It’s also what the price of the option would be at expiration.

  11. Time value of an option depends on a few things. The 2 main factors are time left to expiration, and volatility.

Now that you have some of the basic terminology down when it comes to options, you should read The Options Trader’s Bible to take the next step to understanding options.