In our last FOSO blog, we dove back into the world of options by covering the concept of call and put options, which you can review here if you like. In short, you purchase call options for bullish trades and purchase put options for bearish trades. Building on that foundation, we will delve even deeper into the various parts of an option and how they are standardized across the marketplace.
All option contracts are standardized by the Chicago Board Options Exchange or CBOE. The CBOE was founded in 1973 and has evolved into a prominent place to buy and sell options. They determine the specifications of an options contract such as the contract size, strike prices, and the options expiration date.
When you trade stocks, you are trading ownership shares of a company. However, when you trade options, you are trading contracts instead of direct company shares. Also, the company shares trade on a one to one basis, and when you purchase fifty shares, you own fifty shares of the company in question. When you purchase an options contract, you now have control over one hundred shares of a company. At this point, you have yet to purchase or sell any actual company shares, but you have reserved the right to do so with a binding options contract.
Options are known as a derivative security because the worth of the options contract is based on the price of the stock from which the contract is derived. The price at which an options contract can be purchased is called a strike price. All strike prices have been optimized by the Chicago Board Options Exchange to make the market more manageable. The standard strike prices are broken down in the chart below.
There are some variants as stocks that are heavily traded can have strike prices at smaller increments of a dollar or even less.
When it comes to trading stocks, company shares will always be in existence as long as the company to which they belong is still active and conducting business. This is one of the main differences between trading stocks and trading options, as options expire after a predetermined period of time. Once that time frame has come and gone, the options must either be exercised, meaning you buy or sell the underlying stock, or left to expire worthless. Usually, the last day to trade standard options is the third Friday of each month as they officially expire on the following Saturday. However, there are different variations to standard options such as weekly options, which expire on the Friday of their respective expiration week. Still, the third Friday of the month for expiration is the general rule. Again, it is good to remember; options will need to be exercised, meaning you buy or sell the underlying stock, or left to expire worthless after their expiration date.
In closing, this blog companions together with our FOSO Level 1 Class 7 blog, The Anatomy of Options, which you can read here for a better foundational understanding of options. Finally, if you wish to learn more regarding this topic, please consider signing up for our Foundations of Stocks and Options class, which you can do here. Thank you for reading, and we look forward to seeing you in next week’s Foundations of Stocks and Options blog!