Options Definition:

The right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike price) during a specified period of time. For stock options, the amount is usually 100 shares if traded in the United States or lots of 1000 make up a contract on the Australian Stock Exchange. Options allow the holder to control equity in a limited capacity for a fraction of what the shares would normally cost to buy them outright.stock_chart

Each option has a buyer and a seller.
If the option contract is exercised, the writer (seller) is responsible for fulfilling the terms of the contract by delivering the shares to the appropriate party.
Indexes, which can’t be delivered, instead have the contract settled in cash.
For the buyer, the potential loss is limited to the margin paid to acquire the option. For the buyer, the upside is unlimited. When an option is not exercised, it expires worthless. No shares change hands and the money spent to purchase the option is lost.

Options are most frequently used as either leverage or protection. As leverage, options allow the holder to control equity in a limited capacity for a fraction of the outlay to purchase the shares in their entirety.
As protection, options can guard against price fluctuations in the near term because they provide the right to acquire the underlying stock at a fixed price for a limited time.
Options are very complex and require moderate observation and maintenance.
Options require you to choose: the strike price, the time to expiry and the contract specifications - ie exercise style, number of shares and company it relates to.
Components of options that affect the value of an option include: intrinsic value, time value and delta. Outside forces which also affect the price of an option include: volatility, time decay, interest rates and dividends and the movement of the underlying share.


What are some options strategies?

  • Calls - buy a call option
  • Puts - buy a put option
  • Covered calls - writing options over a stock that you already own
  • Naked puts - writing put options without owning the underlying stock (considerable margin required)
  • Naked calls - writing call options without owning the underlying stock (considerable margin required)
  • Spreads
    • Credit spreads - bear call & bull put credit spreads
    • Debit spreads - bull call & bear put debit spread
    • Strangles - writing calls or puts around a strike price
    • Straddles - buying or writing call or put options at or either side of the current share price
    • Ratio call spreads - take 1 call option and sell 2 or 3 call options
    • Steroid trading - bought call & sold put/bought put &
    • Calendar Spreads - writing short dated options over longer dated bought call options

 

options_tradingMargins: Premium margin and risk margin

 This is the name given to the amount of money (cash or share collateral) that is required should you enter a position that has an open downside.
Trades where you pay money to enter them, such as buying calls or puts, or debit spreads, don’t require margin because the maximum downside is limited to the money you have already put out there. 
Options prices, and therefore options margins are influenced by market volatility.  The more volatile the market, the higher the price of options. 


Expiry and Getting Exercised

For bought calls or puts, it is important to buy longer-dated options where time-decay will not eat into the value of your options.
When writing calls or puts, your aim is to let the option expire worthless so you get to keep the premium and can write again.

Some strategies are perfect for getting exercised if you want to own the shares at a discounted price. Other strategies will be employed to avoid being exercised and being forced to buy the underlying stock outright.

If the chance of being exercised worries you, then you can always write index options which can’t be exercised prior to expiry as they are European style exercise, as opposed to US style exercise on other stock options.