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Chapter 4: Options Terms


Familiarize yourself with essential options trading terminology, including definitions of key terms like options buyer, options writer, strike price, premium, and more.

Option Terms

Options Buyer

An options buyer is a trader who purchases an option contract by paying a premium. This trader gains the right to either buy (call option) or sell (put option) the underlying asset at a specified strike price before or on the expiration date.

Options Writer

An options writer is the trader who sells an option contract and receives the premium from the buyer. The writer takes on the obligation to fulfill the terms of the option contract if the buyer exercises it.

Options Price/Premium

The premium is the monetary value paid by the options buyer to the options writer. It is the cost of acquiring the option contract.

Expiration Date

The expiration date, or maturity date, is the date on which the option contract becomes invalid. After this date, the option can no longer be exercised.

Strike Price

The strike price is the agreed-upon price at which the underlying asset can be bought or sold if the option is exercised. The profitability of the option trade depends on the relationship between the strike price and the current market price (spot price) of the underlying asset.

Spot Price

The spot price is the current market price of the underlying asset. It fluctuates based on market conditions and is crucial in determining the option’s value at any given time.

Long

Going long, or simply long, refers to the act of buying a financial instrument, such as an option or stock.

Short

Going short, or short, refers to the act of selling a financial instrument, often with the intent to buy it back later at a lower price.

Option Chain

An option chain is a listing of all available option contracts for a particular underlying asset, including their strike prices, premiums, trading volumes, and open interest. It provides a comprehensive view of the market for options on that asset.

Naked Options

Naked options refer to selling options without holding an offsetting position in the underlying asset. This strategy is considered highly risky because the potential losses are theoretically unlimited.

Vanilla Options

Vanilla options are standard option contracts with no special or complex features. They include most European and American options and are simpler compared to exotic options.

At the Money (ATM)

An option is at the money (ATM) when the spot price of the underlying asset is equal to the strike price. In this situation, exercising the option results in neither a profit nor a loss.

In the Money (ITM)

An option is in the money (ITM) when it would be profitable to exercise it. For call options, this occurs when the spot price is higher than the strike price. For put options, it occurs when the spot price is lower than the strike price.

Out of the Money (OTM)

An option is out of the money (OTM) when it would not be profitable to exercise it. For call options, this occurs when the spot price is lower than the strike price. For put options, it occurs when the spot price is higher than the strike price.

Options Relationship with Strike Price & Spot Price

Understanding the moneyness of options helps in evaluating their profitability:

  • Spot Price > Strike Price
    • Call Option: In the money (ITM)
    • Put Option: Out of the money (OTM)
    • Formula: Spot price – Strike price
  • Spot Price < Strike Price
    • Call Option: Out of the money (OTM)
    • Put Option: In the money (ITM)
    • Formula: Strike price – Spot price
  • Spot Price = Strike Price
    • Both Call and Put Options: At the money (ATM)

This table summarizes the relationship:

ConditionsCall OptionsPut OptionsFormula
Spot price > Strike priceIn the moneyOut of the moneySpot price - Strike price
Spot price < Strike priceOut of the moneyIn the moneyStrike price - Spot price
Spot price = Strike priceAt the moneyAt the money-

Conclusion

Understanding these key option terms is essential for anyone involved in options trading. By familiarizing yourself with the roles of options buyers and writers, the importance of strike prices and premiums, and the concepts of moneyness, you can make more informed trading decisions.

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Chapter 5: Options Trading Styles
Chapter 6: Underlying Assets
Chapter 7: Benefits of Option Trading
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