A Brief Seminar on Stock Options

To begin with, a stock option is a form of contract between the seller and the buyer. It is connected to listed stock, futures contracts, real estate or exchange index. To make it simpler for you, this article will discuss about options connected only with listed stocks.

The American and European stock option are the two basic types of options. Here are the differences between the two basic types of options:

American style option – This type of option contract can be exercised anytime between the date of purchase and the expiration. This type of option is the most popular option in the market today.

European style option – This type of option contract can only be exercised on the expiration date. Futures option or contracts are commonly in European style option.

Before you buy or sell stock options here are the four major designations of every stock option:

• Name of the associated stock
• Expiration date
• Strike price
• The broker’s commission and the premium paid for the option

Calls and Puts are two of the most popular types of options. Call enables you to own it and gives you the right, but not the obligation, to purchase a stock any time before the option expires at the strike price.

You can also sell an option even without owning them before. This is called writing option and explains the source of options. If you have this type of option, you have the obligation to sell shares any time before the expiration date at the strike price.

Put is the other type of common option. It is almost the same as calls but owning one means that you have the right but not the obligation to sell a stock any time before the expiration date of the option at the strike price.

People trade these things by rarely exercising the option and buy or sell the security. Instead, they can buy back the option if they wrote a put before or sold the option. This method saves commission and other fees.

You will commonly hear about volume and open interest in reference to options. A volume refers to the number of contracts traded on a given day, while the open interest is a little more complicated. An open interest for an option is the number of contracts outstanding on a day.

The open interest increases if a trader opens a position by buying an option from another trader who has not held a position in the particular option. When the trader who opened a new position closes out the position of selling the option, the open interest will either go down or remain the same.

Here is a theory about the relationship for the price of puts and calls:

Price of put is equal to price of call when you deduct the price of call to the stock price, add the present value of exercising price and add the present value of dividends.

To put it simply, you should remember PCSED, where P is the price of put, C is price of call, S is stock price, E is present value of exercise price and D is present value of dividends.

If you are new to options, you should begin by writing covered call options for stocks that is currently trading below the strike price of the option. Alternatively, in simpler terms, begin by writing “out of the money” covered calls.

This is how trading a stock option works. Remember, you should first understand how to trade stock option before you go in the market and start buying or selling.