What is a stock option? A stock option is most commonly defined as a contract that gives the option owner the right, but not the obligation, to buy or sell 100 shares of a specific stock at a pre-set price by a pre-set date.
I’m confident you are already familiar with the concept of being able to buy something at a pre-set price by a pre-set date. That is what a coupon does for you at the grocery store (this metaphor is courtesy of one of my option mentors).
A coupon has an expiration date and it has a price that you have the right to pay – if you choose. You are never obligated to use the coupon. Using a coupon to buy a dozen red apples at the grocery store isn’t much different than using a call option to buy 100 shares of Apple, Inc. in the options market.
Every stock option has a “strike price.” This is the price per share you will buy or sell at if you choose to “exercise” the option. It also has an expiration date. In other words, this is the last date on which the stock option can be bought or sold. Each individual option will have its own value.
This is called the “premium.”
The premium is based per share, so the price you would pay for any option is the premium multiplied by 100.
Different Types of Stock Options
There are two types of stock options: calls and puts. You can buy or sell either a call or a put, giving you four possible basic actions:
Buy a call option (Bullish).
Sell a call option (Bearish).
Buy a put option (Bearish).
Sell a put option (Bullish).
That’s right, you can sell a call or put option even if you don’t own one already.
The financial markets may be the only place where you can legally sell something you don’t own.
If you buy a call option, you have the right (but not the obligation!) to BUY 100 shares at the strike price on or before the expiration date. If you sell a call option, you are giving someone else the right to buy 100 shares from you at or before the expiration date.
If you buy a put option, you have the right (but not the obligation!) to SELL 100 shares at the strike price on or before the expiration date. If you sell a put option, you are giving someone else the right to SELL you 100 shares at or before the expiration date.
The “premium” for any stock option will fluctuate based on a couple of factors. I will cover what makes an option go up or down in value in another blog post.