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1. |
What is a Stock Option? |
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A stock option is a contract entered into between two parties, a buyer and a seller. The buyer has the right, but not the obligation, to trade an underlying asset with the seller at a predetermined price, within a certain time.
There are 2 types of options: a Call and a Put, with the last trade day to be 1 business day before the final trade day of the contract month. This American-type option can be exercised on or before the expiry date and settled in physical scrip.
*An American style option can be exercised any time from its issuance up to its expiration.
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2. |
What is a call option? |
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The buyer pays a premium to buy a call option contract, which gives the buyer the right to buy a specific amount of the underlying shares, on or before a future date (expiry date), at an exercise price (strike). |
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3. |
What is a put option? |
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The buyer pays a premium to buy a put option contract, which gives the buyer the right to sell a specific amount of the underlying shares, on or before a future date (expiry date), at an exercise price (strike). |
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4. |
What is premium? |
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The price at which an option trades is generally called the "premium". The premium is determined by market forces. |
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5. |
What is strike price? |
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The strike price, also known as the exercise price, is the price at which the option buyer and seller agree to trade the underlying stock, if the option is exercised.
A call option whose strike price is below the market price of the underlying stock is in-the-money. Such an option allows the call holder to buy the shares for less than the current market price. A call whose strike price is above the underlying market price is out-of-the-money. Conversely, a put whose strike price is above the underlying price is in-the-money. This means the put holder can sell the asset for more than the current market price. A put whose strike price is below the underlying price is out-of-the-money.
It can be seen from this that only in-the-money options would generally be exercised by their holders because otherwise the holders can buy or sell directly in the market at a better price. If an option's strike price equals the price of its underlying asset, the option is said to be at-the-money (sometimes this term is applied to options whose strike price is very close to the underlying market price but not exactly equal). |
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6. |
What is exercise period (expiry date)? |
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Stock options have an exercise period which limits their validity. After the expiry day of that exercise period, the option can no longer be traded or exercised. |
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7. |
When an investor has bought a stock option contract, how can he close out his position? |
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He can close out his position through one of the following ways:
- Sell the contract at the current premium value;
- Exercise the option contract to deliver or take delivery of the underlying stock;
- Let the option contract expire
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8. |
How do the option buyer exercise a stock option? And what should the option seller do? |
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The buyer has the right to excise a stock option. For call option, the buyer has the right to buy a specific amount of the underlying shares at the strike price. For put option, the buyer has the right to sell a specific amount of the underlying shares at the strike price.
For the option seller, he should prepare the underlying shares for settlement when the call option is being excised. If a put option is being excised, the seller should have enough capital for buying the underlying shares from the option buyer.
Please refer to Trade Execution/Settlement about exercising a stock option in SHK e-Stock Options trading platform. |
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Stock Options
