An option is a contract to buy or sell a stock at a certain price by a certain date.
Put Option: An option to sell a stock.
Call Option: An option to buy a stock.
Here are some key terms/things to remember:
In the US, every option contract is for 100 shares of a stock.
Strike Price: The price at which you buy or sell the stock. For example, if a stock is at $100 and you buy a call option to buy the stock at $50, $50 is the strike price of the call option.
Expiry date: The date by which the buyer of the option can “exercise” the contract, which means they can buy or sell the stock at the strike price.
Credit/Premium: The premium is the amount the buyer pays for the option. It is also called credit from the point of view of the seller because that is the amount the seller receives for an option. These terms are thrown around interchangeably.
Now let’s look at a real example from Yahoo! Finance:
Above is a Tesla Call that expires on April 5th, 2024. We can also see that the strike price is $180 and the last trade price i.e. the premium paid by the buyer or the credit received by the seller is $0.22. The credit is always per share. So when you buy this option you would have to pay $22 because every option contract represents 100 shares.
In The Money vs. Out of The Money: An option is in the money if the strike price of the option is beneficial to the buyer of the option. An option is out of the money if the strike price of the option is beneficial to the seller of the option.
In a put option, if the stock price is at or below the strike price it is in the money. If it is above the strike price, it is out of the money.
For call options it is the opposite, if the stock price is at or above the strike price then it is in the money, and if it is below the strike price it is out of the money.
The more an option is in the money, the more likely a buyer is to exercise their option before the expiry date.
If an option is in the money at expiry, brokers will exercise them automatically.
Why Options Can Be Confusing:
A put is defined as an option to sell a stock. But you can buy or sell a put option. So if you sell a put option, and that option goes in the money, you can be assigned (have to buy) the stock at the strike price of your sold put option. Don’t worry if this is confusing.
A call is defined as an option to buy a stock, if you sell a call option, and that call goes in the money, the buyer of the option can exercise it and you may have to sell your stock at the strike price. Don’t worry if this is confusing.