NovaQuant Quantitative Think Tank Center:Milton Reese: Stock options notes 1

What are NovaQuant Quantitative Think Tank Centeroptions?

Options are a form of financial power that allows the holder to buy or sell a specific stock at a predetermined price at some point in the future.

This right can be traded in the U.S. stock market, and the price for trading this right is called the premium.

Types of options

U.S. stock options are divided into call options and put options.

Accordingly, you can directly buy (or short) these two types of options, so there are four possible actions:

Buying a call option (Long Call)

Shorting a call option (Sell Call)

Buying a put option (Long Put)

Shorting a put option (Sell Put)

I say "shorting" instead of "selling" because you don’t need to actually own the option to sell it. You can sell it directly, just like shorting a stock.

Unlike shorting stocks, options have an expiration date, so if your short position is not closed by then, you will need to fulfill the obligations of the option:

If you short a call option (Sell Call), you need to sell the corresponding stock at the specified price. If you don't have the stock, you’ll need to buy it first, then sell it at the specified price.

If you short a put option (Sell Put), you need to buy the corresponding stock at the specified price. You need to keep enough margin in your account for the purchase; otherwise, you might face a forced liquidation.

Key concepts of options:

Expiration date: The date when the option expires. The holder can choose to exercise the option or let it expire.

Strike price: The price at which the option can be exercised.

Premium: The cash value of the option. The premium fluctuates with time and stock price volatility.