PROGRAMS… Get your programs here…

In the options business, it is hard to tell the players even with a program. And based on the e-mails I have been receiving, this is perhaps a good time to get back to the basics.

To start, let’s understand that you can trade options on individual stocks, stock indexes, interest rates, commodities, futures, and probably… tulip bulbs. Fortunately, all options, regardless of the underlying security, share similar characteristics.

Equally fortunate – since my preference is to avoid overkill - we need only look at options on stocks and stock indexes. Referred to as equity options and index options. And keeping with our good fortune, what works for equity options usually works equally well with index options. That is, aside from subtle differences that are explained in a small section of the account opening documentation you get from your broker.

And now, the terms …

There are two types of equity options: calls and puts. A call gives you the right to buy 100 shares of the underlying stock at a specific price for a pre-determined time period. For example, if you buy a six-month call option on XYZ stock at $50, you have paid for the right to buy XYZ at $50 per share (that’s the specific price we referred to) at anytime, over the next six months (that’s the pre-determined time period). Option traders refer to the specific price (i.e. the $50 per share price in our XYZ example) as the option’s strike or exercise price.

A put option accords you the right to sell 100 shares of the underlying stock at the puts exercise or strike price for a pre-determined time period. If you buy an XYZ six-month $50 put, you have bought the right to sell XYZ at $50 per share anytime over the next six months. Basically then, you would buy a call if you expected the stock to rise (i.e. bullish). You would buy a put if you thought the stock was about to decline (i.e. bearish). In both cases, you would expect the stock to move over the next six months.

The date the option expires, as you might expect, is referred to as the expiration date. Equity options, and most index options, expire on the Saturday following the third Friday of the expiration month. The Saturday expiration simply allows the options clearing corporation to settle all expiring option contract prior to the next trading day.

You can also sell options. Which in the options market, is referred to as writing an option. In much the same way as an insurance company writes a policy. And just to round out our insurance theme, the compensation an investor receives for writing an option – or the price an investor must pay to buy an option - is referred to as the premium.

Altogether now: Option’s trash talk… armed with these basic terms, we can now define in, one simple statement, all the facets of an option contract. When I tell you that “I just bought an XYZ January 50 call…” I purchased an option to buy (a call) XYZ (the underlying security) at $50 (the strike price) per share. And that call will expire on the Saturday following the third Friday in January.

On the oft chance that someone understood what you said, they might ask how much you paid for this option. You can answer $5 (trust me, that was the price), which would mean that the premium you paid would be $5 per share, or $500 per contract.

A bit of explanation is in order. Each XYZ call option grants the buyer the right to buy 100 shares of XYZ. Same with index options, in that they must be multiplied by 100 in order to calculate the total cost per contract. Just to recap; in the above example, one XYZ January 50 call option contract is exercisable into 100 shares of XYZ. The premium for one option is 100 times the quoted per share price ($5.00 per share in the XYZ example), which equals $500 per contract.

Now, if someone asks how much implied volatility did you pay for that call… well that’s for another day!