Understanding Options

Title: Understanding Options

By: Dave Meshkov

What follows is a transcript of the video above.

Options issued and guaranteed by the Options Clearing Corporation (OCC), are listed and typically traded on the Chicago Board Options Exchange. Options are based on the value of underlying securities, such as stocks. An options contract offers the buyer the chance to buy or sell the underlying asset.

Let’s use Zoom as an example of stock here. Does a Zoom call options impact its capital structure? Meaning, when there are Zoom calls or puts issued by the OCC, does it affect Zoom and their company as a whole? Well, Zoom is not involved in the options trade, exercise, or expiration in any way. Because the company Zoom is not the buyer, they do not make or lose money on these options> They are just the underlying. Options are speculative investments by third parties and have nothing to do with Zoom. Zoom is stock. It is a C Corp with stock.

What does it mean to be an American Style Stock? For example, we speculate on Zoom’s stock price over the next 39 months. Can we use options? Well, yes, we need to trade LEAP options.

Let’s Try a Practice Question

Which of these options will be exercised?

A. Short in-the-money put

B. A long out-of-the-money call

The correct answer is A.

In this case, you do not know the strike or the underlying. Overall, we have no information. If it’s in-the-money, it is going to be exercised. Is the seller here happy, or is the short party happy about this? When you have a short put, you then have the obligation to buy. This is that car dealer who says, “Oh man, I promised you I’d buy that Wrangler for $40,000 even though it’s only worth $35,000.” Who decides if it’s going to be exercised–the long or the short party? The long party does. This person had no choice. To put some numbers on it, it is an XYZ call option with 25 strikes. XYZ is trading at what to be in-the-money? XYZ’s trading is at 20, and this person has an obligation to buy it at $25. The long out-of-the-money call is out of the money because XYZ down here is also trading at $20. If you could buy XYZ for $20 in the market, would you ever buy it for $25 via the option? No way.

Important SIE Exam Note

This information is important to know for the exam. The $25 XYZ option is at-the-money when XYZ is trading “at-the-money” and did not give you a premium, $25. If the strike equals the market, what do we call it? At-the-money. What was the max gain on this? Theoretical max gain on the long out-of-the-money call, has not expired yet. It is unlimited. What about the counterpart here? We were having a long out-of-the-money call. You had a counterpart who was short of out-of-the-money calls. Is this person happy or sad right now? Short out-of-the-money means happy days. Since it is out-of-the-money, it will expire, and you will keep your premium.