Keene on the Market: Trade to Win Using Unusual Options Activity, Volatility, and Earnings

CHAPTER 8

Options Basics Primer

What Are Options?

■ What Are Derivatives?

A derivative is a financial product whose value is based on a related asset (also known as the underlying). There are many types of derivatives; this book will cover equity options. Going further, an equity option is a derivative that is exchange traded (meaning that it can be bought by the retail trader with a brokerage account). When you trade options you have the right to buy or sell the equity that is related to the option (call or put) at a set price (strike price) at a set time (expiration date) in the future. It is possible to be at the other end of the options trade, and have the obligation to buy or sell the equity that is related to the option. Remember that the buyer of an option always has the right to exercise his option, while the seller is giving another individual that right to choose. This means that the seller of this option must take delivery of this stock long or short if the buyer decides to exercise his right for long or short stock.

■ What Are Calls and Puts?

A call option is the right, but not the obligation, to buy equity at a strike price by an expiration date. The buyer of this call has the right, but not the obligation, to exercise his option to buy the underlying asset. The seller of the call option has no rights: he or she will be assigned a short stock position at the strike price should the call buyer choose to exercise his or her option to buy the equity (“call away the stock”) ...