Definition of Option Terms
Objectives of trading options, options pricing, disparities in pricing, and complex option strategies will covered in the chapters that follow. There are a lot of terms and concepts introduced, and we need to define a few before moving further.
In the above example, AAPL is the underlying stock. The option holder has the right to buy AAPL at the strike price of $50. The underlying stock price is $51. The underlying price ($51) is more than the strike price ($50) by $1, therefore, the option must be worth at least $1. The option is in the money by $1. The amount the option is in the money ($1) is the intrinsic value. The rights of the option holder expire on the expiration date. The length of time between the purchase of the option and the expiration of the option is the term.
An option is a contract to buy or sell a fixed number of shares, usually 100, of the underlying stock. The premium is the price of an option and is quoted on a per-share basis. An option contract quoted at $1.75 will cost $175, plus commissions. The minimum option purchase is 1 contract. Contracts listed by the exchange typically cover 100 shares of the underlying stock, but that is subject to change as a result of stock splits, mergers, spin-offs, large dividends, or other corporate actions.
The objectives of trading options are discussed in Chapter 2.