Understanding Options
Understanding options in the stock market is difficult for any beginner. It involves complex abstractions and a lot of seemingly complicated words. To help you understand stock options more I will discuss and define some of the technical words used in the stock market.
Call and Put
First of all, an option is the right one has to either buy or sell 100 shares of stock at a given stock price, within a given period. There are two kinds of options: the call option and the put option. The call is a kind of option that gives its holder the right to buy the stock at a specified price within a specified period of time. Holders of call options usually buy these options at around $0.02 or may be $0.05 per share. A call option involving 100 shares of stock would cost around $2 to may be $5 or even higher. The holder of the option is not required to buy the stocks. He just bought the option to buy or not to buy the stocks at a given price within a given period. You exercise your option by either actually buying or selling the stock. If you don’t exercise the option, it becomes an unexercised option. If you own stocks you can write covered calls. Write is a technical term which means to create an option. Covered calls are those options in which the writer actually owns the stocks that are the subject matter of the option. This is opposed to naked calls in which the writer only makes the call but he does not actually own the stocks. The strike price is the price set by the Options Clearing Corporation in which the option can be exercised. The strike price is based in the trading volume, which is the amount of shares a stock is trading over a period of time, and the stock’s current price. A strike price that is below the prevailing stock price is said to be in-the-money whereas a strike price that is above the prevailing stock price is said to be out-of-the-money. A put option, on the other hand, is the option to sell stocks at a given price within a given period of time.
Intrinsic and Time Value
There are two factors to consider in giving value to options. They are the intrinsic value and the time value. The intrinsic value, in the case of call options, is the positive difference between the share’s price and the strike price whereas the time value, also known as the speculative value, is the added money an investor is willing to pay over and above the option’s intrinsic value. If the strike price is equivalent to the current share price, the option is said to have no intrinsic value whereas if the strike price is higher than the share price then it is said to have no intrinsic value and only a purely time value.
At this point, you may still be confused about options, calls, puts and option values. But as you go along you will encounter these words again. I hope that by reading this article you at least gained a working knowledge of these concepts.