Understanding Option Basics: A Guide to Option Terminology

Category : Option Basics | Sub Category : Option Terminology Posted on 2023-07-07 21:24:53

Understanding Option Basics: A Guide to Option Terminology
Introduction:
Options are versatile financial instruments that offer investors the opportunity to hedge risks, speculate on price movements, generate income, and more. The jargon and terminology can be hard to understand if you're new to options. In this post, we will break down the essential option terminology to help you navigate the world of options with confidence.
1 Call option:
The buyer of a call option has the right to buy the underlying asset at a specific price, but not the obligation. When investors expect the price of the underlying asset to rise, call options are used.
2 Put option
A put option gives the buyer the right to sell the underlying asset at a specific price, but not the obligation to do so. Put options are used to protect against a decline in the price of the underlying asset or to speculate on downward price movements.
3 Strike price:
The strike price is the price at which the underlying asset can be bought or sold when the option is exercised. It is important to choose a strike price that is appropriate for your market outlook and risk-reward profile.
4 The date of the end of the year.
The option contract's expiration date is referred to as the expiration date. If not exercised, the option becomes worthless. It's important to remember the expiration date when trading options as the value of the option decreases.
5 In the Money, At the Money, and Out of the Money are the three main ways to get money.
The relationship between the strike price and the current price of the underlying asset is described in these terms.
The strike price of the ITM options is favorable to the current price of the underlying asset. The current price is higher than the strike price. The current price is lower than the strike price.
The strike price of the ATM options is very close to the current price of the underlying asset.
Out of the Money options have a strike price that is less favorable to the current price of the underlying asset. The current price is lower than the strike price. The current price is higher than the strike price.
6 Premium:
The option buyer pays a premium to the seller. It is a representation of the option's potential value and is influenced by factors such as the current price of the underlying, time to expiration, implied volatility, and interest rates.
7 Implied volatility is the measure of the likelihood of something happening.
Implied volatility is a measure of the market's expectations for future price volatility. The option's premium will increase if implied volatility is higher.
Conclusion
Understanding the basics of options trading is important for anyone looking to trade options. You will be better equipped to make informed decisions when trading options if you know the key concepts. It's important to know the risks of options trading and seek professional advice before starting.