Legally binding contracts between buyers and sellers. The buyer of this contract is the holder, who has the right to buy or sell a round lot of the underlying security at a specified price, known as the strike or exercise price. The holder pays a premium for the right, but NOT THE OBLIGATION, to exercise the the contract within a specified time period.
Entity that standardizes options contracts so they can trade on exchanges. This entity sets strike prices and expiration dates and is the issuer and clearing agent for listed options. It is owned by the exchanges that trade options.
Options Clearing Corp (OCC)
What are the two types of options?
Puts and Calls
Options that consists of options of the same type on the same underlying security
Options of the same class that also hve the same expiration date
What are the two exercise styles of options
American and European
Person who has a long position in options, who pays the premium and has the right to exercise the option
Person who has a short position in options, who sells a put or call that they don't own - in other words, they are short the put or call. This person collects the premium and has the obligation to buy or sell the underlying security if it is exercised.
Price of an option
Price at which an option can be exercised
Strike Price (Exercise Price)
Time when option contract ceases to exist or becomes worthless, which is the Saturday following the third Friday of the month at 11:59 ET. The friday before this time is the last trading day.
Negotiated options that trade in the OTC market. They are not standardized or listed on an exchange. OTC options are often used by portfolio managers to help them hedge or protect their portfolios, beacuse these can be custom-designed to meet the portfolio's needs at a specific time.
Contract that gives the option holder the right to purchase 100 shares of the underlying security, at the strike price, until expiration. The holder pays the premium and does not receive dividends. A writer of this contract has the obligation to sell 100 shares of the underlying security at the strike price, until expiration. The writer receives the premium.
Contract that gives the holder the right to sell 100 shares of the underlying security, at the strike price, until expiration. The holder pays the premium for this contract. A writer of this contract sells this short and has the obligation to buy 100 shares of the underlying security at the strike price, until expiration. Writer receives the premium.
Exercise style that allows options to only be exercised during a specific time period, usually the last trading day before expiration.
Exercise style that allows options to be exercised at any time up to expiration
When holder wants to exercise, they notify broker dealer, who notifies OCC. The OCC picks a broker/dealer at random and broker/dealers can pick their customers at random, on a FIFO basis, or any other way that is fair and reasonable. What is this called?
Stock or index options with expiration dates out to 39 months. Only long positins of this can result in long-term capital gain or losses. These occur when these options are held for a period greater than 12 months.
Long-Term Equity Anticipation Participation Securities (LEAPS)
Intrinsic Value + Time Value = ?
Value determined by how much time there is until the expiration date. The more of this means more value and less means less value. The value erodes as it nears the expiration date.
There is intrinsic value when the price of the underlying security is higher than the strike price of the option. What option is this?
This option has intrinsic value when the price of the underlying security is lower than the strike price. What is this option?
When an option has intrinsic value, what is the option called?
In The Money
When the market price of the underlying security is the same as the option strike price, what is this called?
At The Money
Option that has no intrinsic value and made up entirely of time value. Price of underlying security is lower than the strike price of the call, or price is higher than strike price of put.
Out of the Money
When the option premium has intrinsic value only, the option is said to be at what with the underlying stock?
What are the three cycles of expiration dates?
Buyer or holder of this option has the right to buy 100 shares of the underlying security at the strike price up to the expiration date of the option. Bullish strategy.
Maximum Loss: Holder loses premium paid
Maximum Gain: Unlimited because in theory, there is no limit to how high the price of the underlying stock can rise
Breakeven Point: When price of underlying security equals strike price plus premium paid
Maximum Loss: Unlimited because, in theory, the upside potential of underlying stock is unlimited
Maximum Gain: Premium Received
Breakeven Point: Price of Underlying stock = strike price + premium received
Maximum Loss: Premium paid for put
Maximum gain: Strike price - premium paid
Breakeven: When price of underlying security is equal to the strike price minus the premium paid
Maximum Gain: Premium Received
Maximum Loss: Strike Price - premium
Breakeven: Occurs when price of underlying security is equal to the strike price minus the premium received
Exercise Limits are restrictions on the number of options contracts on the same side of the market that can be exercised over how many days?
5 Consecutive business days
Options strategy that uses long and short options of the same type - either puts or calls - on the same underlying security. There are vertical (price)and horizantal (time).
To establish this spread, an investor buys a call with a lower strike price and writes a call with a higher strike price. Spread increases in value or widens as the stock rises. Bullish position.
Maximum Loss: Premium
Maximum Gain: Unlimited
Debit Call Spread
Investor is establishing the spread for a net credit; he's receiving a premium. Investor writes the call with the lower strike price and purchases the call with the higher strike price. Bearish position. Spread loses value or narrows as the price of the underlying stock falls to or below lower strike.
Max Gain: Premium Received, calls expire
Max Loss: Unlimited
Credit Call Spread
Investor buys put with higher strike and sells put with lower strike. Bearish position. Spread increases in value or widens as underlying stock falls to and goes through lower strike price.
Max gain: Expiration if both put are exercised
Max Loss: Premium Paid
Debit Put Spread
Investor is establishing the spread for a net credit; premium is received. To establish spread, investor writes the put with the higher strike price and purchases the put with the lower strike price. Bullish position. The spread loses value or narrows as the price of underlying stock rises to or goes through the higher strike price put.
Maximum Gain: Premium received
Max Loss: difference between strike prices - net credit
Credit Put Spread
A call and a put on the same underlying security with the same strike price and the same expiration date. These bet on volatility.
Max Gain: Unlimited (because a straddle holder is long calls)
Maximum Loss: Premium Paid
Breakeven: Upside - Premium of call and put added to call strike price
Downside - premium of call and put subtracted from strike price
Maximum Gain: Premium Received
Maximum Loss: Unlimited (Short Calls)
Breakeven: Upside - Premium for call and put added to strike
Downside - Premium for the call and put subtracted from the put strike price
Strategy for speculating on the volatility of the underlying stock. Similar to straddle in that it involves buying or selling a call and a put on the same underlying stock. However, contracts have different strike prices and/or expiration months.
Maximum gain: Unlimited
Maximum Loss: Combined premiums paid
Breakeven: Upside - Combined premiums of the call and the put added to the CALL strike price
Downside - breakeven point is the combined premiums of the put and the call subtracted from the PUT strike price.
Largest option exchange that has trading posts scattered throughout the trading floor where options on stocks, indexes and other securities trade.
Chicago Board Options Exchange
Automated execution system that allows member firms to transmit option orders directly to the trading post. When these orders are executed, the system automatically notifies the member firm of the completed transaction. What is this system?
CBOE Order Support System (OSS)
At each trading post, there is an individual who keeps track of public limit orders and oversees the opening and closing of the trading day. This person works for the exchange and cannot trade for their own account. Who is this person?
Order Book Official (OBO)
When trading is halted on a stock, trading in options on that stock is halted by the options exchange. What CBOE rule is this?
This stock cannot be used to cover short calls. What CBOE rule is this?
Member firms have to report to the exchange information about members, employee and customer accounts that have 200 or more option contracts on the same side of the market. This doesn't constitute a position limit violation; its only a reporting requirement. What CBOE rule is this?
What is the first thing that must happen when opening an options account?
Each option account must be approved by a registered options principal (ROP) prior to trading.
What is the second thing that must be done to order an options account?
Account activity must also be approved by a ROP
A principal who is qualified and registered to supervise options activity
Registered Options Principal
When a customer account is approved for option activity, extra option information is required in addition to the basic account information. What is the customer given?
Options Disclosure Corporation
Document prepared by the Options Clearing Corporation (OCC), that details the risks involved in trading options. The customer must be sent this document at or prior to account approval by ROP.
Option Disclosure Document
The option agreement is given to the customer and the customer must sign and return it within how many days of receipt?
Document that must signed and returned within 15 days of receipt that verifies net worth, annual income, and that the investor has read and understood the document. They also confirm that they understand their approved level of trading and will abide by the position limits imposed by the exchange.
Option disclosure document
Unless customer is buying options only, what must be signed and ROP approved prior to the first trade?
What is the first step to opening an options account?
Complete new account form
What is the second step to opening an options account?
Customer loan agreement and margin agreement must be fully executed unless customer is only buying options
What is the third step to opening an options account?
Options disclosure document must be provided prior to the ROP approving the account
What is the fourth step to opening an options account?
Customer must return signed options account agreement to the brokerage firm within 15 days of the new account approval. However, if customer is late signing the option agreement, only closing transactions may occur.