Trading listed options
What are options?
An option is a standardised financial derivative contract that gives the owner the right (but not the obligation) to buy or sell 100 shares of an underlying asset at a specific price, referred to as the ‘strike price’, at any time up to the given expiration date.
There are two basic types of option: call options (the right to buy) and put options (the right to sell). The simplest options strategies are to buy a call if you think the underlying share price will rise, or to buy a put if you think the price will fall. More complex options strategies combine the buying and selling of calls and puts to maximise the probability of returns in certain market conditions.
The market price of an option, also known as the premium, reflects both the intrinsic and extrinsic value of the contract.
An option’s intrinsic value is simply the difference between the strike price and the underlying share price. Options have intrinsic value when they are ‘in the money’. For example, call options have intrinsic value if the strike price is below the underlying share price, while put options have intrinsic value if the strike price is above the underlying share price. Options that are ‘out of the money’ or ‘at the money’ have zero intrinsic value.
Extrinsic value is driven by other factors affecting the probability that the option will expire in the money; specifically, how volatile the underlying market is and how much time there is until the contract expires. This means that an out-of-the-money option with zero intrinsic value might still have extrinsic value if, for example, there’s enough time for the underlying price to shift in the option holder’s favour before it expires.
Learn more by watching these guides on the basics of options:
© 2003-2024