Understanding
Stock Options Trading
and Technical Analysis Basics

Options Lingo - Understanding Stock Options Investing

Now that we understand the basic concept of option trading, it's time to mention the terminology used in the option trading world.

Premium - The premium is the amount that you pay up front for the option. This amount is once-off and non-refundable.

Strike Price - The strike price is the amount that you agree to pay for the stock at a later date.

Underlying Stock - The underlying stock is the stock for which you are purchasing the option.

Exercising Options - No, we are not talking about choosing to jump up and down in front of an exercise video featuring Anna. By exercising an option, you are using your right to buy, and actually purchasing the underlying stock.

Expiration Date - The expiration date is the last day for you to exercise your option. If you don't exercise it by then, your option will expire worthless. In the United States, the expiration date is the 3rd Friday of the month. So if you have a June option, that option will expire on the 3rd Friday of June.

American Options - American options are options (not limited by any geographic boundaries) that allow you to exercise the options at any time until the expiration date.

European Options - European options are options (not limited by any geographic boundaries) that allow you to exercise the options at only the expiration date. Do check with your local Options Exchange which form of options are used in your country.

Contract - Option investing is carried out in numbers of contracts. One contract equates to 100 underlying shares. If you buy one call option contract, you are buying the right to buy 100 shares of the underlying stock.

In-The-Money - An option is said to be in-the-money if it is worth something if you choose to exercise it now.

Out-Of-The-Money - An option is said to be out-of-the-money if it is worthless if you choose to exercise it now.


In our previous housing example, you paid a Premium of $5,000 for the Call Option, or the right to buy the Underlying house, at a Strike Price of $110,000. You may exercise the right to buy the house at the Expiration date of 6 months' time.

Looking at our 2 possible scenarios, if the underlying house is worth $200,000 in 6 months' time, your option is considered In-The-Money. If you had bought it, you would have made a profit of $200,000 - $110,000 - $5,000 = $85,000. Your profit would be the market value of the house, minus the amount you paid for it, and minus the option Premium you paid at the start for the right to buy the house.

In the 2nd scenario, if the underlying house is worth $80,000 in 6 months, your option would be Out-Of-The-Money, and you would not want to exercise it and pay more for the house than it was actually worth. Your loss would be the initial $5,000 you paid for the option.

Easy-speak
Item Scenario 1 Scenario 2
Initial Premium $5,000 $5,000
Strike Price $110,000 $110,000
Expiration Date 6 months 6 months
House Market Value $200,000 $80,000
In-The-Money? In Out
Profit $85,000 - $5,000


Now let's look at an option investing example in the stock market:

You are monitoring stock ABC, which is currently priced at $19.00 on the 1st of June. You think ABC is doing well, and should go up in price very soon.

You decide to buy a June Call Option for ABC, with a Strike Price of $20.00, and an Expiration Date of the 3rd Friday of June (options always expire on the 3rd Friday of the month). The Premium for the option is $0.75. As of now on the 1st of June, the option is Out-Of-The-Money, since ABC's price of $19.00 is still below your Strike Price of $20.00

On the 3rd Friday of June, you find that ABC has increased in price by $3.00 bringing it up to $22.00. Your option is now In-The-Money, and you could exercise it now for a profit. Your profit would be the market value, minus your strike price, minus your premium, which is $22 - $20 - $0.75 = $1.25.

Easy-speak
ABC 1st June 3rd Friday
Initial Premium $0.75 $0.75
Strike Price $20.00 $20.00
Expiration Date 3rd Friday 3rd Friday
Current Stock Price $19.00 $22.00
In-The-Money? Out In
Profit - $0.75 $1.25


Be aware that since each option contract covers 100 underlying shares, all costs and profits should be multiplied by 100 for the proper perspective.

And also be aware that option investing in general is very risky, and should only be done after understanding stock options intimately. Since options provide such a large amount of leverage (you can earn a larger percentage, as well as lose a larger percentage), you could lose a fortune without properly understanding stock options.


Calls and Puts Basic Options Strategies

Other Topics in this Guide

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