Options, according to the OIC The Options Industry Council, are contract(s) to buy or sell a specific financial product known as the underlying instrument or underlying interest of the option. With equity options, a stock, ETF (exchange traded fund) or similar product. The contract states the specific price, or strike price, at which the contract may be exercised.
Contracts do have an expiration date. At which time if the contract was not acted upon the option expires, valueless and ceases to exist.
There are two varieties of options, calls and puts. You can buy or sell either type depending on the strategy you are using.
Buying and Selling
If you purchase a call, you have the right to purchase the underlying instrument, stock options for example, at the strike price on or before expiration. If you purchase a put, you have the right to sell the underlying instrument on or before expiration. In either case, the option holder has the right to exercise the option during its term or to let it expire worthless.
If you write or to sell an option, known as a short option position. This obligates the writer to complete their side of the contract should the option holder wishes to exercise.
When you sell a call as your opening transaction, you’re obligated to sell the underlying interest at the agreed strike price, if assigned.
When you sell a put as your opening transaction, you’re obligated to buy the underlying interest, if assigned.
You have no control on whether a contract is exercised or not. Plus the holder of the contract may exercise it at any time before expiration.
That said, just as a buyer can sell an option back into the market rather than exercising it, a writer can purchase an offsetting contract to end their obligation to meet the terms of a contract provided they have not been assigned. To offset a short option position, you would enter a buy to close transaction.
The Option Premium
The purchase price of the option is called the premium. If you sell, the premium is the amount you receive. The premium can and does fluctuate. The premium is the negotiated price between the a willing buyer and seller.
The purchase price of an option is affected by 4 variables:
* underlining asset price
* time decay
* implied volatility
* interest rate
As a buyer of options, you begin with a net debit. If you don’t sell your option at a profit or exercise it you stand to loss a part or all of the capital you invested. Should you make money on a transaction, to find you profit you would subtract both the cost of the premium and the brokerage commission from any income to determine your net profit.
As a seller, you begin with a net credit as you collected the premium. If the option is never exercised, the premium is yours to keep. Should the option be exercised, you still keep the premium but are obligated to buy or sell the underlying stock if assigned.
With Binary Options there are only 2 possible outcomes:
1) a fixed monetary amount of the asset if the option expires in the money
2) nothing at all if the option expires out of the money
Commissions & Fees
The variables determining the fees are: services provided, whether trades are assisted or self service online, type of underlying assets on which options are being traded.
Some of the more popular brokerages include: Scottrade – Options First, TD Ameritrade, Charles Schwab, ETRADE and Fidelity.
The important consideration here is to interview a few of them to see which matches your trading style, services and platforms desired and personality.
Should you care for a more exclusive consultative service in order to find the brokerage and account manager to handle your affairs, the Options Group, specializes in not only Executive Search but with offices world wide provides market intelligence and strategic consulting for the discerning investor.