Underlying Stock Price
The value of an equity option depends heavily upon
the price of its underlying stock. As previously
explained, if the price of the stock is above a call
option’s strike price, the call option is said to be in-themoney.
Likewise, if the stock price is below a put
option’s strike price, the put option is in-the-money.
The difference between an in-the-money option’s
strike price and the current market price of a share of
its underlying security is referred to as the option’s
intrinsic value. Only in-the-money options have
intrinsic value.
Premium
Option buyers pay a price for the right to buy or sell the underlying security. This price is called the option premium. The premium is paid to the writer, or seller, of the option. In return, the writer of a call option is obligated to deliver the underlying security (in return for the strike price per share) to a call option buyer if the call is exercised. Likewise, the writer of a put option is obligated to take delivery of the underlying security (at a cost of the strike price per share) from a put option buyer if the put is exercised. Whether or not an option is ever exercised, the writer keeps the premium. Premiums are quoted on a per share basis. Thus, a premium of $0.80 represents a premium payment of $80.00 per option contract ($0.80 x 100 shares).
Benefits of Exchange-Traded Options
Orderly, Efficient, and Liquid Markets ... Flexibility ... Leverage ... Guaranteed Contract Performance. These are the major benefits of options traded on securities exchanges today. Although the history of options extends several centuries, it was not until 1973 that standardized, exchange-listed and government-regulated options became available. In only a few years, these options virtually displaced the limited trading in over-thecounter options and became an indispensable tool for the securities industry.
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Strike Price
The strike price, or exercise price, of an option is the
specified share price at which the shares of stock can
be bought or sold by the holder, or buyer, of the option
contract if he exercises his right against a writer, or
seller, of the option. To exercise your option is to
exercise your right to buy (in the case of a call) or sell
(in the case of a put) the underlying shares at the
specified strike price of the option.
The strike price for an option is initially set at a
price which is reasonably close to the current share
price of the underlying security. Additional or
subsequent strike prices are added as needed. New
strike prices are introduced when the price of the
underlying security rises to the highest, or falls to the
lowest, strike price currently available. The strike
price, a fixed specification of an option contract,
should not be confused with the premium, the price at
which the contract trades, which fluctuates daily.
If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in-the-money because the holder of this call has the right to buy the stock at a price which is less than the price he would have to pay to buy the stock in the stock market. Likewise, if a put option has a strike price that is greater than the current market price of the underlying security, it is also said to be in-the-money because the holder of this put has the right to sell the stock at a price which is greater than the price he would receive selling the stock in the stock market. The converse of in-the-money is, not surprisingly, out-of-the-money. If the strike price equals the current market price, the option is said to be at-the-money.