Options trading can be one of the most profitable ways to make money, but understanding the terminology can be confusing if you’re just getting started. Here are the key options terms you need to understand when trading options.
What is an option?
Options are contracts that give their owner the right, but not the obligation, to buy or sell an underlying asset such as a stock. Options come with an expiration date, after which the option either has value or expires worthless. The option’s value depends on the price of the underlying asset.
Options can generate big profits in a short period of time, but you’ll need to be right about the timing of the price change in the underlying asset as well as the move itself in order to profit.
Common options terms explained
Here are some of the most common options terms and definitions.
American-style option
American-style options can be exercised at any time prior to the expiration date.
At-the-money
An option is considered “at-the-money” if the strike price is equal to the price of the underlying asset. For example, a call or put option would be at-the-money if the stock price and the strike price were the same.
Call option
A call option gives its owner the right to buy the underlying asset at a specific price until the expiration date. The seller of the call option must sell the underlying asset at the strike price if the option is exercised.
European-style option
European-style options can only be exercised during a specific time period before expiration.
Expiration date
The expiration date is the day when the option expires. After expiration, the option no longer exists.
Holder
The holder of an option is the buyer and has the ability to exercise the option or not.
In-the-money
An option is considered “in-the-money” if it has intrinsic value. For example, a call option on a stock would be in-the-money if the stock price is above the strike price.
Intrinsic value
An option’s intrinsic value refers to the in-the-money portion of the option premium. For example, if a call option has a strike price of $40 and the stock price is $45, the option has an intrinsic value of $5.
Open interest
Open interest refers to the number of open options contracts that have not been closed or settled.
Out-of-the-money
An option is considered “out-of-the-money” if it has no intrinsic value. For example, a call option on a stock would be out-of-the-money if the stock price is below the strike price.
Put option
A put option gives its owner the right to sell the underlying asset at a specific price until the expiration date. The seller of the put option is required to buy the underlying asset at the strike price if the option is exercised.
Strike price
The strike price, or exercise price, is the price that the option’s owner can either buy or sell the underlying asset.
Time value
An option’s time value is the portion of the option premium not attributed to its intrinsic value. For example, if a call option has a strike price of $40, a premium of $8, and the stock price is at $45, the time value equals $3, because the option’s intrinsic value is $5.
Volume
Volume represents the number of options contracts traded over a specific time period, typically one day.
Writer
The writer of an option is the seller and is required to fulfill the obligations of the contract as long as the option is open.
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