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Options
Options Explained
An option is a contract that gives the buyer the right,
but generally not the obligation, to buy or sell an
underlying asset at a specific price on or before a
certain date. An option, just like a stock or bond, is a
security.
2 Options | Scotia iTRADE
What are Options?
Options Explained
An option is a contract that gives the buyer the
right, but generally not the obligation, to buy or
sell an underlying asset at a specific price on or
before a certain date. An option, just like a
stock or bond, is a security. It is also a binding
contract with strictly defined terms and
properties.
The two types of options are calls and puts:
A call
A call gives the holder the right to buy a
specific amount of a certain asset at a
certain price within a specific period of
time. Calls are similar to having a long
position on a stock. Buyers of calls hope
that the stock will increase substantially
before the option expires.
A put
A put gives the holder the right to sell a
specific amount of a certain asset at a
certain price within a specific period of
time. Puts are very similar to having a short
position on a stock. Buyers of puts hope
that the price of the stock will fall before
the option expires.
Why Use Options?
Investors and Traders use options to:
Protect stock holdings from a decline in
market price
Earn income from current stock holdings
Prepare to buy stock at a lower price
Position for a big market move even when
they aren’t sure which way prices will
move
Benefit from a stock price's rise or fall
without incurring the cost of buying or
selling the stock outright
Other benefits include
Efficient, Liquid Markets
Flexibility
Leverage
Limited Risk
Guaranteed Contract Performance
Options
Options are used, amongst others, to protect stock
holdings from a decline in market price, earn income
from current stock holdings and to buy stock at a
lower price.
3 Options | Scotia iTRADE
Standardized option contracts provide orderly, efficient, and liquid option markets. Except under special
circumstances, stock option contracts generally cover 100 shares of the underlying stock. The strike
price of an option is the specified share price at which the shares of stock will be bought or sold if the
buyer of an option (the holder) exercises his/her option.
As a result of this standardization, option prices (premiums) can be obtained quickly and easily at any
time during trading hours. Additionally, closing option prices for exchange-traded options are published
daily in many newspapers. Option prices are set by buyers and sellers on the exchange floor, where all
trading is conducted in the open, competitive manner of an auction market.
Flexibility
Options are an extremely versatile investment tool. Because of their unique risk/reward structure,
options can be used in many combinations with other option contracts and/or other financial
instruments to create either a hedged or speculative position.
Leverage
A stock option allows you to set the price, for a specific period of time, at which you can purchase
or sell 100 shares of stock. To buy the right to control the stock in that way, you pay a price (the
premium) which is only a percentage of what you would have to pay to own the stock outright.
That leverage means that by using options you may be able to increase your potential benefit from
a stock's price movements.
Option Buyer pays a premium and secures a right
Seller collects a premium and has an obligation
Seller’s Right
Call To buy shares at a specified price over a specific time period
To deliver shares at a specific price over a specific time period
Keeps the premium from selling the option
Put To sell shares at a specific price over a specific time period
To buy shares at a specific price over a specific time period
Keeps the premium from selling the option
4 Options | Scotia iTRADE
Options Pricing
Understanding Options Pricing
The specific stock on which an option contract is
based is commonly referred to as the
underlying security. Options are categorized
as derivative securities because their value is
derived in part from the value and
characteristics of the underlying security. A
stock option contract's unit of trade is the
number of shares of underlying stock which are
represented by that option. Generally speaking,
stock options have a unit of trade of 100 shares.
This means that one option contract represents
the right to buy or sell 100 shares of the
underlying security.
Strike Price
The strike price, or exercise price, of an
option is the specified share price at which
the shares of stock can be bought or sold by
the holder, or buyer, of the option contract
if they exercise their right against a writer, or
seller, of the option. To exercise your option
is to exercise your right to buy (in the case of
a call) or sell (in the case of a put) the
underlying shares at the specified strike
price of the option.
The strike price, a fixed specification of an
option contract, should not be confused
with the premium, the price at which the
contract trades on the market, which
fluctuates, based on market conditions.
In-the-Money
If the strike price of a call option is less than the
current market price of the underlying security,
the call is said to be in-the-money because the
holder of this call has the right to buy the stock
at a price which is less than the price that would
have to be paid to buy the stock in the stock
market.
Out-of-the-Money
If a put option has a strike price that is greater
than the current market price of the underlying
security, it is also said to be in-the-money
because the holder of this put has the right to
sell the stock at a price which is greater than
the price that would be received for selling the
stock in the stock market.
Out-of-the-Money and At-the-
Money
The converse of in-the-money is, not
surprisingly, out-of-the-money. If the strike
price equals the current market price, the
option is said to be at the-money.
Premium
Option buyers pay a price for the right to buy or
sell the underlying security. This price is called
the option premium. The premium is paid to
the writer, or seller, of the option. In return, the
writer of a call option is obligated to deliver the
underlying security (in return for the strike price
per share) to an option buyer if the call is
exercised and, likewise, the writer of a put
option is obligated to take delivery of the
underlying security (at a cost of the strike price
per share) from an option buyer if the put is
exercised. Whether or not an option is ever
5 Options | Scotia iTRADE
exercised, the writer keeps the premium.
Premiums are quoted on a per share basis.
Thus, a premium of $1.00 represents a
premium payment of $100.00 per option
contract ($1.00 x 100 shares).
Underlying Stock Price
The value of an option depends heavily upon
the price of its underlying stock. If the price of
the stock is above a call option's strike price, the
call option is said to be in-the-money. Likewise,
if the stock price is below a put option's strike
price, the put option is in-the-money. The
difference between an in-the-money option's
strike price and the current market price of a
share of its underlying security is referred to as
the option's intrinsic value.
Only in-the-money options have intrinsic value.
For example, if a call option's strike price is $45
and the underlying shares are trading at $60,
the option has intrinsic value of $ 15 because
the holder of that option could exercise the
option and buy the shares at $45. The buyer
could then immediately sell these shares on the
stock market for $60, yielding a profit of $ 15
per share, or $ 1,500 per option contract
When the underlying share price is equal to the
strike price, the option (either call or put) is at-
the-money. An option which is not in-the-
money or at-the-money is said to be out-of-the-
money. An at-the-money or out-of-the-money
option has no intrinsic value, but this does not
mean it can be obtained at no cost.
Time Value
The primary components of time value are time
remaining until expiration, volatility, dividends,
and interest rates. Time value is the amount by
which the option premium exceeds the intrinsic
value.
Option Premium = Intrinsic
Value + Time Value
For in-the-money options, the time value is the
excess portion over intrinsic value. For at-the-
money and out-of-the-money options, the time
value is the option premium.
Time Remaining Until Expiration
Generally, the longer the time remaining until
an option's expiration date, the higher the
option premium because there is a greater
possibility that the underlying share price might
move so as to make the option in-the-money.
Time value drops rapidly in the last several
weeks of an option's life.
Volatility
Volatility is the propensity of the underlying
security's market price to fluctuate either up or
down. Therefore, volatility of the underlying
share price influences the option premium. The
higher the volatility of the stock, the higher the
premium because there is, again, a greater
possibility that the option will move in-the-
money.
6 Options | Scotia iTRADE
Dividends
Regular cash dividends are paid to the stock
owner. Therefore, cash dividends affect option
premiums through their effect on the
underlying share price. Because the stock price
is expected to fall by the amount of the cash
dividend, higher cash dividends tend to imply
lower call premiums and higher put premiums.
Options customarily reflect the influences of
stock dividends (e.g., additional shares of stock)
and stock splits because the number of shares
represented by each option is adjusted to take
these changes into consideration.
Interest Rates
Historically, higher interest rates have tended to
result in higher call premiums and lower put
premiums.
Read an Options Quote
Options are widely quoted in the financial
press. Although there may be differences in
how the statistics are presented, invariably
the option tables always focus on the same
core information. To help us define terms,
imagine the month is September and we're
checking out option activity in our favorite
newspaper.
Here is how one option quote might look for
a fictional call on shares of a company
known as ABC Inc.
ABC 10/18/14 20 Call
ABC
Underlying Security. The name of the
particular security (or index such as OEX or
TSX) that an investor has the right to buy
or sell according to the terms of a listed
option contract. This is known as the
‘underlying security’.
10/18/14
Expiry date October 18, 2014.
All options have fixed expiration dates.
Each class of options (all options of the
same type, either calls or puts, on the
same underlying security, are considered
the same class) has a set of four expiration
dates. Together, they are known as the
option's ‘cycle’. There are three cycles. One
cycle is January, April, July, and October;
another is February, May, August and
7 Options | Scotia iTRADE
November; and the third is March, June,
September and December.
Normally options expire on the Saturday
following the third Friday of their specified
month. In practice, however, this means
that the third Friday is the last day you
have to trade your option (some
exceptions do exist).
The holder of an option has the right to
buy or sell (depending on if the option is a
call or a put) the underlying stock any time
until the expiration date. In addition,
option writers can terminate their side of
the contract by buying to close at any time
before the option expires.
20
Exercise or ‘Strike’ Price. The price at which
the buyer may buy stock from the writer
(in the case of a call) or sell stock to the
writer (in the case of a put). In the example
above, if the buyer exercises the option, he
is guaranteed a price of $20 a share for
ABC regardless of how high the price of
ABC might rise before the expiration date.
Premium Price
The premium price is the market price of
an option contract at a given time. When
you purchase an option contract, you pay
the premium price immediately. The
premium quoted is for one option contract
but because that contract covers 100
shares (known as the multiplier, usually
100 shares for stocks), you must multiply
the premium dollar amount quoted by 100
to derive the actual cost of the contract.
Thus, a $3 premium actually means one
contract costs $300. Please note that
option premiums fluctuate.
Call
Class There are two types of options, calls
or puts, each is referred to as a class of
options. All of the calls listed for the same
underlying stock are one class and all of
the puts listed for that stock are the other
class.
Get an Options Chain
An Options chain is a form of quoting options
prices through a list of all the options for a given
security. It is a listing of all the call and all the
put option strike prices along with their
premiums for a given maturity period.
You can access the Option chain by navigating
to Quotes & Research, enter the stock you want
to purchase the options on, and select ‘Options
Chain’ from the fly-out menu.
8 Options | Scotia iTRADE
You can also enter the desired stock, click on ‘Go’ and then select ‘Options’ from the submenu.
You will then have access to the Options chain. From here, you can select the following information:
Chain (Calls and/or Puts)
Sort by Month or Strike Price
Strike Price
Expiry
Option Type
Click on ‘Get Chain’ to view your selection.
9 Options | Scotia iTRADE
[Type a quote from the document or the summary of an interesting point. You can position the text box
anywhere in the document. Use the Drawing Tools tab to change the formatting of the pull quote text
box.]
Call Options can be found on the left, Put Options on the right
Shaded areas indicate In-The-Money Options
Click on ‘Analyse’ to access Options Greeks
Use the Quick Menu drop down to trade Options
10 Options | Scotia iTRADE
Invest in Options
Options trading can form an important part of a successful investment portfolio. At Scotia iTRADE®, we give you the power to trade options easily and track the ups and downs of the market.
Select Account
Select Options
Select Symbol or use magnifying glass
to search
Select Market
Select Option Type, i.e. call or put
Enter Expiration and Strike
Select Order Type, i.e. buy to open, sell
to close, sell to open
(covered/uncovered), buy to close
(covered/uncovered)
Enter number of contracts
Enter Price Type and Term
Click ‘Preview Order’. Check your order
carefully before inserting your Access
Code and submitting your order
11 Options | Scotia iTRADE
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