In my last article, the idea of options on olive presses gave an example of how options benefited both the option buyer and seller.
The option's benefits of leverage, limited risk and income generation are the same in today's financial markets as they were in ancient times.
There are even more advantages available today, including the ability to protect an asset against a loss in value. Also the ability to participate in a loss of asset value with the same benefit of leverage and limited risk are a part of today's option trading.
To use and trade options, an understanding of how the contract is structured is the first step. The standard option contract has these elements.
The TYPE of option contract will be either a "call" option which is the right to buy something. Or it will be a "put" option which is the right to sell something.
The "something" in an option contract is a financial asset known generically as an underlying asset.
The option contract will have a strike price. The option contract will have an expiration date.
Every option contract traded has these standard elements.
Tying the elements together looks like this:
A call option is the right to buy the underlying asset at the strike price until the option expires.
A put option is the right to sell the underlying asset at the strike price until the option expires.
For an example of what this translates to in today's market here is an option on Apple Corp (AAPL | news | PowerRating | PR Charts ).
AAPL May 120 Call
This call option would give the option buyer the right to buy AAPL stock, (the underlying asset) at $120.00 (the strike price) until May (the expiration month).
Another example would be an AAPL May 160 Put
This put option would give the option buyer the right to sell AAPL stock, (the underlying asset) at $160.00 (the strike price) until May (the expiration month).
The expiration date for a stock option is considered to be the close of trading on the 3rd Friday of the expiration month. This expiration date is standard for stock options.
A single stock option controls 100 shares of stock. In the example above, the AAPL May 120 call option would give the option buyer control of 100 shares of AAPL stock and the right to buy the 100 shares at a price of $120.00.
The AAPL May 160 put option also controls 100 shares of stock and the right to sell 100 shares of AAPL stock at a price of $160.00.
These are the basic elements of the stock option contract. My next article will discuss how to buy call options and the situations in which buying a call option would be the appropriate options trading strategy.
John Emery has been a professional trader for more than a decade, trading in stocks, options and stock indexes on a daily basis. A former proprietary trader, Emery has written numerous articles for TradingMarkets over the years on topics ranging from trading basics to his own trading methods and strategies. Emery uses options both to trade and as a risk reduction tool.
