1. Options give the investor the right to buy or sell
the underlying asset or instrument.
2. If you buy options, you are not obliged to buy or
sell the underlying asset, you just have the right.
Meaning, you can choose to buy the options, sell the
options or do nothing and let it expire, depending on
what is most advantageous to your position.
3. Options are either call or put. Call options give the
power to the buyer to buy the options. Put options give
the buyer the right to sell the options.
4. Options are quoted per share, but are sold in 100
share lots. Meaning, if the investor purchases 1 option,
he or she is buying 100 shares.
5. The investor only has to pay the option premium and
not the total amount of shares like if you are buying
per stock. For example, if the option premium of a $50
stock is $3, the total amount of the contract is $300
per option. So if the investor is buying 3 options at $3
per option, since he or she is buying in 100 share lots,
the total payment would be $900 (3 options x 100 shares
per option x $3 option premium).
6. Buying shares is different. You have to pay per
share. For example, the stock price of Company A is $80.
If you want to buy 100 shares, you would have to pay
$8,000. Whereas with options, if you wish to invest on
100 shares, you just have to enter into a contract
wherein you would buy one option at a certain option
premium.
7. If you wish to buy the stock at the end of the
contract, that will be the only time where you will pay
the total amount of money that is equivalent to the
number of option contracts, multiplied by contract
multiplier. Refer to #6 for example.
8. If the buyer exercises his rights to buy the option
(call), the seller (or the writer) is obliged to deliver
the underlying asset.
9. If the buyer exercises his rights to sell the option
(put), the seller is obliged to purchase the underlying
asset.
10. If the buyer wishes to exercise his rights to either
buy or sell the underlying asset, the seller must either
sell it or buy it at the strike price, regardless of the
its current price.
11. In case the buyer of the option decides to do
nothing at the end of the contract for whatever reason,
the seller keeps the option premium as profit.
12. In computing your profit, you have to consider 2
things: the option premium and the strike price. If the
option premium is $2 and the strike price is $50, your
break-even point is at $52. So in order for you to make
a profit, the stock must be more than $52. If the stock
falls below $52, say $49, and there is no time left, you
won’t lose $3 per stock. What you will lose, however, is
the option premium you have paid for the contract.
Note: The numbers were just picked out of the air to
illustrate how options trading work. In real world,
numbers vary widely so you have to carefully study each
of them.