Options Basics

What is an Option?investor must realize that the $1.00represents a
An option is a traded security that is a derivativeprice of $1.00 per share, not per contract.
product.Remember that each contract is worth 100
By derivative product we mean that it is ashares. This means thatif you were to buy one
product whose valueis based upon or derivedoption contract at a quoted price of
from the price of something else. Sincewe are$1.00, your total cost will be $100.00 (1 contract x
talking about stocks, a stock option is based upon,$1.00 pershare x 100 shares per contract). If you
amongother things, the price of the underlyingwere to buy 10contracts for $1.50 per contract,
stock.your total cost will be
There are also options on other traded securities$1500.00. Use the formula below when calculating
such ascurrencies, indexes and interest rates, buttotal dollarcost of the option.
here we will limitour discussion to stock options, orTotal Dollar Cost of Trade = Number of
options based on stocks.Contracts x Price per
A distinguishing factor of an option is that is aContract x 100
depreciatingasset in the sense that it has a limitedOption contracts are literally a sales agreement
life, and has to beused before the date on whichbetween twoparties. The two parties are the
it expires. As time goes by, theoption loses valuebuyer (or holder) and theseller (or writer). When
as it moves closer to its expiration dateyou buy an option contract you areconsidered to
When we speak of options in terms of volume,be long the option. When you sell an
we refer tocontracts. Each stock option contractoptioncontract, you are considered to be short
is equivalent to 100shares of stock. When we talkthe option. This, ofcourse, is assuming you had no
about two contracts, we aretalking about 200previous position in the saidoption.
shares, 10 contracts; we are talking aboutIn an option contract, although it seems as though
1,000 shares, 75 contracts 7500 shares and sothe buyer andseller must be tied together, they
on.are not. You see, the buyerdoesn't really buy
Amount of Shares Equivalent Amount of Optionfrom the seller and the seller doesn't reallysell to
Contractsthe buyer.
100 1In reality, an organization called the OCC or
200 2Options Clearing
1000 10Corporation steps in between the two sides. The
7500 75OCC buys fromthe seller and sells to the buyer.
15000 150This makes the OCC neutral,and it allows both the
50000 500buyer and the seller to trade out of aposition
100000 1000without involving the other party.
NOTE: It is important to understand the dollarAmazing Options Trading Strategies For Safer
cost of optionsbefore actually trading them. WhenInvesting and
an option is quoted at $1.00per contract, theExplosive Profits!