How to Start Trading Stock Options
Learning the Basics First Is the Key to Successful Options Trading
Aug 26, 2008
The apparent complexity of stock options is largely due to the sheer amount of data involved in identifying and valuing them. However, a few moments spent learning the basics will highlight the fact that they don’t have to be complicated at all.
There are only four components to an option – the type (call or put), the underlying stock, the expiration date, and the strike price. All four components are identified in the option symbol alone. However, a detailed description of each component is necessary.
Option Type – Call or Put?
A call option – also called a contract -- is the right to buy 100 shares of a particular stock. A put option (or contract) is the right to sell 100 shares of a particular stock.
In general, a call option is considered bullish or optimistic. If a trader expects the option’s underlying stock to move higher, the right to buy 100 shares of that stock at a specified price in the future also becomes more valuable. In turn, that option appreciates in value. They’re also referred to as just ‘calls’.
Conversely, a put option appreciates in value when the underlying stock moves lower. The right to sell shares at a specified price at some point in time in the future becomes more valuable when that stock’s price is dropping. Therefore, put options are deemed bearish. Sometimes they’re just called ‘puts’.
Underlying Stock or Index
The very first portion of an option symbol simply identifies which stock or index it’s linked to. This is usually just the stock’s ticker symbol, though a growing number of stocks, indices, and options have forced the industry to use other underlying ticker codes.
Expiration Date
Neither puts nor calls can be owned indefinitely; they expire eventually. Depending on which stock they represent, there may be puts or calls with expirations ranging from one month to three years, and several points in time in between.
All options expire on the third Friday of their expiration month. They can be sold or exercised (used to actually buy or sell their underlying shares at the agreed-upon price) anytime up until expiration.
Strike Price
Finally, all option contracts are an agreement to buy or sell a stock (or index) at a particular price, called the strike price. The further away the stock’s actual price is beyond the strike price, the more valuable the option is.
Note that put options become more and more valuable as the underlying stock or index moves under the strike price.
Example
IBM calls make for an adequate example. Their October 115 calls use the ticker ‘IBMJC’.
The first three letters of the option ticker (‘IBM’) are the underlying stock’s ticker. Keep in mind there may be a need to use something other than the stock’s ticker in the option’s nomenclature, if using that ticker creates overlapping option tickers.
The ‘J’ denotes the strike price of $115. The options industry has standardized this strike code schedule.
The ‘C’ denotes that this is a call that expires in October. The options industry has also standardized this nomenclature as well. A through L are reserved for calls – one letter for each month. M through X are reserved for puts, and again each month has its own letter.
As with anything, new traders can best learn this nomenclature by writing out and labeling a few option tickers. It should be comfortable for any trader looking to start trading options.
