The concepts covered here:
- basic option terminology
- premium, intrinsic value, time value and time decay
- basic terms of equity and index calls and puts, the rights of long option contracts and the obligations of short contracts
- when options actually expire and when they last trade
- how and when to exercise long option contracts
- assignment notification and how to avoid it
- basic information about the options marketplace
For more information on these subjects you might turn to one of the many classes located here in the Learning Center. You may also download and install on your computer a free copy of The Options Toolbox, a comprehensive and interactive educational software program that covers much of these concepts in greater depth.
How can you use equity options?
Consider some of the benefits of equity options:
- protection of stock holdings from a decline in market price
- increased income against current stock holding
- prepare to buy a stock at a lower price
- benefit from a stock price rise...buying the stock outright
If you anticipate a certain directional movement in the price of a stock, the right to buy or sell that stock at a predetermined price, for a specific duration of time can offer an attractive investment opportunity. The decision as to what type of option to buy depends on whether your outlook for the underlying security is bullish or bearish. If your outlook is bullish, buying a call option creates the opportunity to share in the upside potential of a stock without having to risk more than a fraction of its market value. Conversely, if you anticipate downward movement, buying a put option will enable you to either participate financially in a downward underlying stock move or to protect underlying shares against downside risk without limiting profit potential. Purchasing equity calls or puts allows you to position yourself according to your market expectations so that you may potentially profit and/or protect yourself with limited risk.
How can you use index options?
Consider some of the benefits of index options:
- benefit from an up or down move in the broad market or a specific industry sector
- protection of a portfolio of stocks from a decline in value
- diversification for investment capital
Like equity options, index options offer the investor an opportunity to either capitalize on an expected market move or to protect holdings in the underlying instruments. The difference is that the underlying instruments are indexes. These indexes can reflect the characteristics of either the broad equity market as a whole or specific industry sectors within the marketplace.
Index options enable investors to gain exposure to the market as a whole or to specific segments of the market with one trading decision and frequently with one transaction. To obtain the same level of diversification using individual stock issues or individual equity option classes, numerous decisions and transactions would be required. Employing index options can defray both the costs and complexities of doing so.