All you need to know about options in just 1 page!

Purchasing "call" and "put" options. What is paid for the option is called "premium." This is a debit transaction. That means you are taking your hard earned dollars and betting that the underlying stock will either go up of down. It's no different than Las Vegas. 

When you combine that with the fact that about 80% of options expire worthless, you have to question someone's sanity who bet's on a stock moving in a particular direction. When you purchase an option (put or call), essentially, what you are doing is buying time - during which you hope the stock will perform the way you want. The more time you buy the more premium you pay. You can buy one month, two months, three months, six months - even more than 2 years of time (on certain stocks).

Disappearing Premium

Options are wasting assets. They're like “ice”. They melt away a little at a time -- until their value completely disappears by expiration. Why? Because you are buying “time”. Every day that goes by, there is less time until the expiration of that option. The less time that remains, the lower the value of the option.

 An option with four weeks to go to expiration may have a value of $2.50. Assuming the stock doesn't move, the same option with three weeks to expiration may be worth only $2.00. With only two weeks to expiration, it may only be worth $1.25. The third week, it may go down $.65 (from $1.25 to $.60). By the time the last week rolls around, the value is just $.60 - heading to zero in a big hurry.

**Important Fact: Option premium erodes SLOWLY during the EARLY part of the life of the option. As time goes by, the rate of erosion INCREASES more RAPIDLY.

Strike Prices

All "optionable" stocks will have a choice of strike prices. Option traders have a choice of strike prices to trade - usually relatively close to where the stock is trading. If a stock is trading at $50, you'll likely be able to trade the $35, $40, $45, $50, $55, $60, and $65 options. The prices of the options will vary depending on the strike prices. Your choice of which option to trade, will have a large affect on the success or failure of your trade.

 Strike Price Increments

The increments between strike prices will vary depending on where the stock is trading. Strike prices below $25 are in $2.50 strike price increments: $5.00, $7.50, $10.00, $12.50, $15.00, $17.50, $20.00, and $22.50. Strike prices above $25 are in $5.00 strike price increments: $25.00, $30.00, $35.00, $40.00, $45.00, and $50.00, etc. Strike prices stay at $5.00 increments all the way up to $200, when they become $10 increments: $200, $210, $220, and $230 etc.

 There are exceptions to these rules of thumb. Some very liquid lower priced stocks will have $1.00 strike price increments. The market makers feel that there is sufficient demand for the options that they open up additional strikes. The same holds true with very liquid stocks that trade in the $30 to $50 range. Many are likely to have $2.50 increments.

Another exception is when a stock undergoes a stock split. A stock that is trading at $100 might split 3-for-1. That will create a new strike price of $33.33. For every one $100 option contract owned, the purchaser will now own three $33.33 option contracts. There is no gain or loss of value - just some unusual strike prices. The same is true for a 2-for-1 stock split. An $80 call option on a stock that is trading $80 before the split will turn into two $40 call options after the split. Again, the value hasn't changed - just redistributed to two options instead of one.

Option Trading Hours

Stock options stop trading at 4 p.m. each trading day (except for a few holidays here and there when the market is only open a 1/2 day). On the other hand, many index options continue to trade until 4:15 p.m.

Option Expiration

Options expire every month, but "options expiration" is a little different. Options don't expire at the end of a calendar month as one might expect. Stock options cease trading on the third Friday of each month. If you look at a calendar for March, 2006, you'll see that the third Friday in March falls on the 17th. The March option cycle consisted of four weeks.

Some option cycles will be five weeks long. It happens four times a year. As a result, the premiums will be higher because you're buying an additional week of time. Case in point, look at the April, 2006 calendar. The third Friday in April falls on April 21st. There are five Fridays between March 17th and April.

Two Styles Of Options

There are two kinds of options - American and European. When trading options on stocks, you will be trading the American style of options. The European style of options are primarily on indexes.

Option Chains

You need to spend a lot of time going over option chains. Options chains will give you more in depth information.