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Lesson 2: Introduction to Options

Options, options for beginners, option call, option put

Options, options for beginners, option call, option putListed for the first time in 1973 in the United States, Options are a highly versatile financial instrument. Options are the best way to manage our savings and our time. All in all, we need one hour a day to devote to this tool to get a good annual income. They are certainly the ideal for those who do not have much time to devote to the markets or for those looking for a way to make the most of their savings, alongside the trading with options with their job.

Let's start by looking at the difference between equity and option. The stock is a share in the ownership of a company that decides to subscribe to the Stock Exchange. Companies issue shares for raising capital to invest and thus avoid borrowing from banks.

An option is a contract between two parties, the buyer and the seller, that gives the buyer the right to buy or sell an underlying within a fixed date at a pre-set price. The underlying may be an equity, an index, a future, a commodity, etc. The options are derived products; they are instruments created directly by the markets and not by reference companies.

Options are subject to expiration. Unlike stocks, in fact, that are listed throughout the year, the options have a monthly expiry that occurs, usually, on the third Friday of the month, or weekly. The pre-set price of the underlying is known as the strike.

There are two types of options:

  1. CALL, the buyer has the right, but not the obligation, to buy an underlying at a given price (strike), within a certain date (expiration) by paying a sum of money (premium).
  2. PUT, the buyer has the right, but not the obligation, to sell an underlying at a given price (strike) within a certain date (expiration) by paying a sum of money (premium).

Another element of the options is the premium, that is, the share of capital that the market requires us to buy an option. An example of an option you can see below.

Options, options for beginners, option call, option put, apple, aapl

AAPL is the ticker of the underlying (Apple), Dec 15 '17 is the option expiration date (December 15, 2017), 180 is the strike, CALL is the option type and 1.76 is the premium.

So, we have already seen the first four elements of an option:

Call/Put: the type of option. At expiration data: Call you buy an underlying, Put you sell an underlying.

Strike: the price we will pay an underlying at the expiration date.

Expiration date: the last day that an option is valid.

Premium: the sum of money we pay for buying an option.

Very important, each option holds 100 shares of the underlying. In our case, 1 Apple option moves 100 stocks of the company. By purchasing the option, we will pay a premium of $ 176.00 (equal at 1.76 x100) that will give us the right (but not the obligation) on expiry to buy 100 Apple shares at $ 180.00 each.

By buying a CALL option (like above on Apple), we will earn if the stock will rise above the break-even point. By purchasing a PUT option, we will earn if the stock will fall below the break-even point level. Otherwise, we will lose the premium paid.

What is and how to calculate the break-even point? You will see it in the next article.

  

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