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November 4, 2009
Understanding Options
There is quite a bit to understanding options so in today’s article we will focus on a couple of things. First we will look at the definition of an option, a call option and a put option. Second we will take a quick look at some facts crucial to understanding options. Lastly, we will take a look at what it means when a company grants employees stock options, not to be confused with trading options.

An option is a contract (see options contracts) giving the owner the right but not the obligation to buy or to sell a security at a certain price on or before a specific date. Call options give the buyer the right to the underlying security at a specific price on or before a certain date, and put options give the owner the right to sell the underlying security at a certain price on or before a certain date. Investors buy a call option if they think that the price of the security is going to rise before the option expires. Options traders buy a put option if they think the price of the security is going down before the option expires.

Facts that every trader should know when options trading include the following:
  • The strike price is the price in which the stock or underlying security can be sold or bought per the options contract.
  • The expiration date of an option is the month that that the option expires. Options actually expire on the third Friday of the month.
  • Options are actually quoted in per share prices but they are only sold in 100 shares lots. This means that you would pay $400 for a call option that is quoted at $4.
Investors new to trading options should not confuse employee stock options with trading options. When a company grants stock options to its employees the following details are provided:
  • Grant price – this is the price in which the employee can purchase the stock. (This price is given on the day the stock options are granted) If an employee exercises the option and the grant price is lower than the stock market price on that day, then the options are “in-the-money.”
  • Shares – the employee is told the number of shares of a company’s stock that he or she is allowed to purchase under the options grant. Options are not only granted by publicly traded companies, but are also granted by companies that plan to go public in the future.
  • Vesting date – this date is the first date that options can be exercised and they must be exercised before the expiration date. Employees buy shares at the grant price when exercising an option regardless of the price the stock is trading at that day in the stock market.

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posted by Stephen W. Bigalow at 7:45 AM

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