what are stock options? | what is a stockoption? what are stock options? i was recently asked this question by a visitorto my web site, www.optionsizzle.com. you may have seen the term “stock optionsâ€in the financial section while scanning the news. or perhaps, you’ve encountered theterm as an employee and were offered stock
current aapl stock price, options in your company. so, what are stockoptions? can these options be used to your advantage? yes! there are two different typesof stock options. let me help you understand the difference. what are stock options – employee stockoption (eso)
an employee stock option (eso) is a type ofnon-cash compensation that is typically issued to management as part of an executive compensationpackage. technically, an eso is classified as a non-standardized option because it hasseveral differences from an exchange traded option. the reason companies offer this typeof compensation to management is because it provides management with incentive to runthe business well. the stock of a well managed company with good growth potential is likelyto rise, rewarding the management team. here are some differences between an eso andan exchange traded option: 1) an eso may not be traded. that means thatcannot be bought or sold in the open market on any kind of exchange. an eso is strictlyissued from the company to the employee.
2) the quantity of the eso is determined bythe company and is not standardized like an exchange traded option. the strike price orexercise price is usually the price of the company stock. 3) the duration of an eso varies and it canbe many years to expiration, unlike an exchange traded option that has a shorter life spanto expiration. what are stock options – exchange tradedoptions an exchange traded option is a standardizedcontract that is traded over the counter on a specific exchange. standardized means thatthere is a standard set of rules governing the trading of that exchange traded option.these are the types of options that you will
typically only have access to since they aretraded on an exchange and available to the public. 1) unlike an eso, one standardized optioncontract represents one hundred shares. so if i bought one apple (aapl) option contract,i would actually control one hundred shares of that stock. if i decided to exercise thatcontract, then i would be purchasing one hundred shares of stock for every one option contracti exercised. 2) there are two types of standardized optioncontracts. you can be a buyer or a seller of an option and each gives you specific rightsor obligations. to keep it simple in the example below, i will explain only the concept ofbuying the two types of options.
a call option gives you the right to buy theunderlying asset (stock or future) at a set strike price. it is a right and not an obligation.you pay a premium or deposit for the option contract which gives you the right to ownthe stock at a set price on or before a set date. when you buy a call option, you expectthe price of the underlying asset to go higher in order for the option contract to becomeprofitable. what you have at risk is only the premium that you paid for the option contract.so, in the case of purchasing a home, you would put down a deposit to show the selleryou were a serious buyer. if a few days later a tornado destroyed the house, you would loseonly your deposit amount and not the full value of the home. i know there are probablyways to get your deposit back, but i wanted
to give you a visual. a put option gives you the right, but notthe obligation, to sell the underlying asset (stock or future) at a set price on or beforea set date. you pay a premium or deposit to own that right to sell. when you buy a put,you want the value of the underlying asset to go lower in order for you option to becomeprofitable. buying a put option is referred to as shorting the underlying asset. manyrefer to put options as insurance. recall the example above of the house destroyed bythe tornado. if you were the seller of that house, then you would have paid an insurancepremium to recoup the full value of the intact house and not the current, lower value ofthe destroyed house.
the cost to you of rebuilding the house toits former state is the insurance premium you paid and nothing more. 3) an option contract has a determined expirationdate on which the option will expire. option buyers need to exercise (or sell) the stockoption before this date. an option which has a long time to expiration is more expensivethan an option with a shorter expiration date. 4) an option contract has an agreed pricewhich is called the strike price. the strike is the price at which buyers of call optionscan buy the stock prior to expiration. it is also the price at which buyers of put optionscan sell the stock. what are stock options – my tips
1) a stock option is usually bought at a significantlylower price than the actual price of the underlying asset, so you don’t have to put up as muchmoney to control the same amount of shares as if you were buying the underlying asset.this is one of the reasons why i use options than the underlying asset. 2) because of the tremendous amount of leverageand the amount of shares you can control with options, you have to be extra careful. thereare many components to the pricing of options. keep in mind that over ninety percent of optioncontracts expire worthless so if you are thinking of putting your entire account in one optioncontract, then you might not have a account in the future.
3) the market trend will usually dictate whichtype of stock option to buy. if the market is in an uptrend, you would look to buy calls.alternatively, if the market is in a downtrend, then you would look to buy puts. trading stock options may sound complicated,but it is much easier than it seems once you master some basic terminology and techniques.all the actual paperwork of the option contract is handled through brokers and stock exchanges.all you have to do is to consult with your financial advisor on whether it’s a goodtime to buy or to sell stock options. it is important that you understand how the systemworks, so that you manage your risk and don’t incur great losses.
what are stock options conclusion: there you go! i hope you enjoyed this articleabout what are stock options? make sure you sign up for the next installment of my series. �
