Options Education - The Fundamentals
What is an option?
In a nutshell, an option is a contract that gives its holder the right (but not the obligation) to buy or sell a certain item at a specific price on or before a specific date… and while an option contract can be written for almost any asset class imaginable, our focus here will be on options that are written for specific stocks and/or baskets of stocks (such as those that make up the S&P 500, for example).
Options that give their holder the right to buy a specific stock (or index) are called call options, and options that give their holder the right to sell a specific stock (or index) are called put options. Whenever stocks are involved, all of the major U.S. exchanges have agreed that each contract represents the right to buy or sell exactly 100 shares of the underlying stock… and trading of partial contracts is never allowed.
In addition to identifying whether it is a right to buy or to sell, each contract also lists the specific price (called the strike price) at which the holder of the option can buy (or sell) the underlying security, as well as the date at which the contract expires (called the expiration date).
On the major U.S. option exchanges, strike prices for stocks are usually set at multiples of $5, though lower priced stocks also have options with strike prices that are multiples of $2.50. In addition to this standardized practice for strike prices, the exchanges have also uniformly agreed that the expiration dates for stock options will always fall on the third Friday of the month named in the contract. It should be noted that index options usually expire around the same time of the month as stock options; however, each index option has its own set of rules, so be sure to seek clarification from your broker before entering into any index option trades!
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