IV. Basic Options Strategies
Review of Terms
Call OptionA contract that gives the holder the right to buy the underlying for the strike price any time until expiry. Put Option A contract that gives the holder the right to sell the underlying for the strike price any time until expiry. Strike Price (Exercise Price) The price that the underlying asset will be bought or sold at if an option contract is exercised. Premium A premium is the price that is paid for an option contract. Underlying The underlying is something which an option contract is based on. This could be a stock, index, foreign currency, interest rate, or a futures contract. The underlying is commonly referred to as the: underlying interest, underlying asset, underlying security, or the underlying stock. Writer A writer is someone who sold an option contract to open a position. The writer is the person who is taking on the risk, (underwriting the risk). Someone who sells an options contract they already own is not a writer, they are just closing an existing position. An option writer is said to be "short" the option they wrote. Holder The holder is the person who bought an option contract. Someone who buys an option they previously wrote is not a holder, they are just closing an existing position. An option holder is said to be "long" the option they bought. Long If you own a security you are said to be long that security. Short If you sell a security that you didn't already own you are said to be short that security. Buy to Open Buying to open a position is when you buy a contract that you don't already own. Sell to Close Selling a contract that you currently own. Write (Sell to Open) Selling an options contract that you don't already own. The writer is the person taking on the risk, (underwriting the risk). Someone who sells an options contract they already own is not a writer, they are just closing an existing position. An option writer is said to be "short" the option they wrote. Buy to Close Buying to close is when you buy a contract that you are currently short. Covered Writing Writing an option when you also hold a position that can fulfill the obligation being taken on by writing the option. The position could be in cash a convertible security or the underlying security itself. For example you could write a covered call option if you owned enough shares of the underlying stock Uncovered (Naked) Writing Selling an option when you don't have a position that could be used to fulfill the obligation of the option. Naked call writing carries unlimited risk, while naked put writing is limited to the strike price of the option. Exercise & Assignment Exercise is when the option holder decides to use the option to buy or sell the underlying stock at the strike price. Assignment is when an option writer is required to buy or sell the underlying stock due to the obligation from writing the option. An option holder exercising an option will cause an option writer to be assigned.
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