Profit Previous Month: 750.00 USD - Profit Current Month: May 2024 : 343.00 USD - Updated 13/05/24 - Details in Trade Report
Basic Option Trading – Types of Transactions
Types of Options
An option contract has always the following defining parameters :
- type of option : put or call
- underlying : the stock it is about
- the quantity of shares : usually 100 shares per contract
- the strike price : the share price at which the contract is executed
- the expiration date of the contract : the date after which the contract stops to exist
- the premium : the price of the contract
Put Option
A put option contract gives the owner of the put option the right (not the obligation) to sell 100 shares of the underlying stock, at the strike price before the expiration date, and the buyer of the contract will pay the premium to obtain this right to the seller of the contract.
As long as the contract has not expired, the seller of the put option has the obligation to buy the 100 shares of the underlying at the strike price, when the buyer executes his right.
Call Option
A call option contract gives the owner of the call option the right (not the obligation) to buy 100 shares of the underlying stock, at the strike price before the expiration date, and the buyer of the contract will pay the premium to obtain this right to the seller of the contract.
As long as the contract has not expired, the seller of the call option has the obligation to sell the 100 shares of the underlying at the strike price, when the buyer executes his right.
Basic Option Transactions
There are 4 basic transactions in option trading. These are :
- Buy to Open (BTO)
- Sell to Open (STO)
- Buy to Close (BTC)
- Sell to Close (STC)
The term Open refers to the fact in which an option trader initiates, or opens, an option position for himself by buying or selling an option contract.
A buy to open transaction is the opening of a long position on an option by an option trader. This means that the option trader actually buys the option contract and acquires the rights of the owner of the option. For this he will have to pay the price of the option (aka the premium) to the seller of the option contract. Being long refers to actually owning the option and if you own something you can only make a profit if the price rises or goes up (hence the term “being long” if you expect or want the price or market to go up).
As you probably know, it is possible to sell shares on the stock market without actually owning them, if your broker allows you to do this with your account. It is also possible on the option market to sell options even without owning them in the first place. Selling shares or options without owning them in the first place is also called shorting.
A sell to open transaction is the opening of a short position on an option by an option trader. Meaning that in the near future you either have to close your position or you have to deliver on your obligations written in the contract. The sell to open transaction enables the seller to receive cash or the premium for the option he has sold.
The term Close refers to the fact that an option trader wants to close his position, meaning he wants to exit the position he has in his account for a specific option.
A buy to close transaction is the closing of a short position on an option by an option trader. Meaning that he buys back the option contract he has previously sold. For this transaction he will have to pay a debit equal to the price of the option.
A sell to close transaction is the closing of a long position on an option. In this case it simply means that the option trader is to close out an options position by putting in an order to sell the contract he already owns. For exiting the position with this transaction he will receive a credit equal to the price of the option.
When a position is not closed or exited before the expiration, the following situations are possible:
- the option is out-of-the-money and expires worthless: in this case the broker will close the position in your account by executing a close transaction with a $0 credit or debit depending your position. This will clear the position in the accounts of both parties of the contract.
- the option is in-the-money and the owner of the option exercises the option: in this case the owner of the option (via the broker) will sell the underlying shares to the seller of the put contract or will buy the shares from the seller of the call contract, both in accordance with the terms of the contract.
Want to continue the options learning journey ? : https://www.tradingoptionscashflow.com/introduction-to-options-trading-an-attractive-investment-opportunity-for-traders/
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