Introduction to Stock Options
A stock option represents a contract between a buyer and seller. In this agreement:
- Buyer's Role: Pays a premium to acquire the right (but not obligation) to buy/sell the underlying asset at a predetermined price (strike price) on or before expiration.
- Seller's Role: Receives the premium but may be obligated to fulfill the contract terms if exercised.
Two Primary Option Types
- Call Options
Grant holders the right to purchase the underlying stock. - Put Options
Grant holders the right to sell the underlying stock.
The Four Pillars of Option Contracts
1. Underlying Asset
The specific stock tied to the option (e.g., "TUTU" shares in our example).
2. Strike Price
The fixed price at which the underlying asset can be bought/sold upon exercise.
3. Option Premium
- The market price of the option contract.
- Influenced by factors like time to expiry and implied volatility.
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4. Expiration Date
- The last day to exercise the option.
- Unexercised options expire worthless, resulting in premium loss.
Practical Examples
Call Option Scenario
- Contract: TUTU $36 Call expiring March 18
- Premium: $4/share ($400 total for 100 shares)
- Rights: Buy TUTU shares at $36 anytime before expiry.
Put Option Scenario
- Contract: TUTU $40 Put expiring March 18
- Premium: $3.90/share ($390 total)
- Rights: Sell TUTU shares at $40 before expiry.
Moneyness Classification
Options fall into three categories based on the stock price vs. strike price:
| Option Type | In-the-Money (ITM) | At-the-Money (ATM) | Out-of-the-Money (OTM) |
|---|---|---|---|
| Call | Stock Price > Strike Price | Stock Price = Strike Price | Stock Price < Strike Price |
| Put | Stock Price < Strike Price | Stock Price = Strike Price | Stock Price > Strike Price |
Where to Find Option Details
- Option Chains: Standardized listings across trading platforms (e.g., TUTU's chain shows available contracts).
- Platform interfaces may vary but maintain consistent data hierarchies.
FAQs
Q1: Why buy options instead of stocks directly?
Options offer leverage—controlling 100 shares with less capital than buying outright. However, they expire, making timing crucial.
Q2: What happens if I don't exercise my option?
It expires worthless, and you lose the premium paid. No further obligation exists.
Q3: How is the option premium determined?
Factors include:
- Time remaining until expiration
- Volatility of the underlying stock
- Distance between stock price and strike price
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Q4: Can I sell an option before expiry?
Yes! Most traders close positions by selling the contract in the market rather than exercising it.
Key Takeaways
- Options derive value from underlying assets without requiring ownership.
- Premiums reflect market expectations about future price movements.
- Moneyness indicates immediate exercise profitability.
Note: This content is educational only—consult financial advisors before trading. Past performance doesn't guarantee future results.