You’ve probably heard about options if you’ve ever watched a stock market show or read an investment guide. They’re contracts that give their owner the right to buy (or sell) something at a certain price at any time before the contract expires. Options are complicated, but they can be useful for investors who want to bet on stocks without buying them outright. In this post, we’ll explain how options work and why they matter in traditional finance—even if you’re not planning on buying or selling any of these contracts yourself!
Option type – call or put?
You can buy the underlying stock at a specified price when you buy a call option. This means that if the stock price goes up, your option will be worth more than when you bought it.
If you sell a put option, then someone else has given their right (or obligation) over something to you when they buy that put from you. If their value goes down below some level that has been agreed upon between both parties (called striking price), then as soon as possible afterward they must sell those shares at whatever market prices are available at that time – even if it means selling them for less than what was originally paid for them!
Strike price is the price at which an option can be exercised. A strike price is set before trading begins and is usually at $5, $10, $20 or $50 increments. For example: if you buy a call option with a strike price of 80 on Apple stock (AAPL), then your maximum loss is limited to the amount paid for that particular contract–or 100% of its purchase price in this example ($800).
The expiration date is the date on which an option expires. Options typically expire three months or less from their purchase date, though they can be held until they reach their expiration date (often referred to as “rolling over”). The expiration date is set in advance and is not affected by market fluctuations.
The expiration date can be used to time the market; for example, if you think that a stock will rise over the next month but would like some assurance of this before purchasing it outright, buying an option that expires in three months may help you achieve your goal without having to pay full price for shares of stock today.
Intrinsic value is the difference between a derivative’s strike and market prices. In other words, it’s the amount by which an option can be exercised if you want to buy or sell an underlying asset at that price. If you hold a call option with a strike price of $20 and it’s currently trading at $22 per share, then your intrinsic value would be 2 x ($20 – $22) = -$2 per share since exercising now would result in a loss of two dollars per share compared with simply buying shares on the open market.
Intrinsic value can also be negative: if an investor holds put options with strikes above current stock prices (for example), then those options will have negative intrinsic values until expiry–and beyond that point if they’re still out-of-the-money when expiration arrives
- Time value: The difference between the strike price and the underlying asset’s current price.
- In-the-money: An in-the-money option has intrinsic value, as it can be exercised for more than its current market price. For example, if you own a call option with a strike price of $50 on Apple stock at $60 per share (a 10% discount), then your call option is in-the-money because you could exercise it and sell your shares at $60 instead of waiting until expiration date when they would only be worth $50 per share.
- Time decay: As an option’s expiration date approaches, its time value declines–this is known as “time decay”.
Options can be complex, but they’re useful.
Options are an advanced type of financial instrument that allow you to make money on stocks without actually buying them. They’re not for everyone, but they can be useful for short term trades or long term investments.
Options can be used to hedge against risk, leverage your investment and even speculate on price movements–but only if you understand how they work!
If you want to learn more about options, we recommend checking out our blog post on the basics.