For many publicly traded stocks, investors can buy options that allow them to buy or sell a specified number of shares at a certain price.
- A call option allows the holder to buy shares at the strike price.
- A put option allows the holder to sell shares at the strike price.
Options are time limited, that is, each option expires at a designated time, known upfront by both the buyer and seller. Most stock options expire on the third Saturday of the month; although some highly traded stocks may have associated options that expire at other times.
An Example of Call Options Expiration
Fictional Stock DEF is highly traded and options are issued to expire on the third Saturday of each month. The stock price of DEF is $50 and two call options are issued at strike prices of $45 and $55.
If the stock price remains at $50 when the market closes on the third Friday, the call option with the $45 strike price will be considered in-the-money, that is, the option will be exercised, and the holder will be able to buy 100 shares at the price of $45. The call option with the $55 strike price will expire out-of-the-money, and the option will have no value, that is, expire worthless.
Put Options are the Opposite of Call Options
In the above example, a $45 put option will be out-of-the-money and worthless, and a $55 put option will be in-the-money. In the real world, there are likely to be both call and put options with a number of different strike prices, but the stock price at the close of business on the day of options expiration is the dividing line between in and out of the money.
Investors who hold options all the way to expiration will be required to make good on options that expire in-the-money. Small investors will either need to sell the option before expiration, or have enough funds available to buy the shares for a call option, or enough margin to obtain shares for selling in the case of a put option.
Longer Term Options and LEAPS
Although there are options expiring each month, investors can buy or sell options that have a longer time period before expiration. LEAPS are long term options that expire more than a year from the current date.
Options Nomenclature: How Options are Named
Earlier this year, option symbols on stocks were changed to be uniform for shares traded on the New York Stock Exchange and the NASDAQ, which uses four letter symbols.
In the case of the fictional company DEF, the option symbol would read:
DEF101218C00050000
DEF is the symbol, 101218 is the date in the YYMMDD format, (year, month and date), C stands for Call (P for put) and 00050000 is the strike price of $50.00.
Options Premiums and Expiration
Option premiums are the amount of value that an option exceeds the strike price. Premiums generally decline as the option approaches expiration. Knowing how expiration works and the proper way to buy and sell options will help the trader protect his position and increase profits.