How options work


Writing and buying options

The person who creates and sells the option contract is the writer. The person who buys and holds the option contract is the buyer.

Options can be bought and sold on several public options exchanges in North America – the Chicago Board Options Exchange is the largest.

Call options

A call option gives the buyer the right to buy the underlying stock at the strike price by the expiry date. The writer is obligated to sell the underlying stock to the buyer if they exercise the call.

Put options

A put option gives the buyer the right to sell the underlying stock at the strike price by the expiry date. The writer is obligated to buy the underlying stock from the buyer if they exercise the put.

Exercise and assignment

If a buyer holding an option wishes to buy or sell the underlying stock at the strike price, they have “exercised” the option.

When the writer of an option is forced to buy or sell the underlying stock, they are “assigned.”

In-, at- and out-of-the-money options

Buyers of an option contract will choose to exercise an option if it is “in-the-money.” For a call option to be in-the-money, the price of the underlying stock must be higher than the strike price. For a put option to be in-the-money, the price of the underlying stock must be lower than the strike price.

If an option is at-the-money, then the price of the underlying stock is equal to the strike price. This applied to both call and put options. A buyer normally won’t exercise an option that is “at-the-money” since there is no profit to be made.

If an option is “out-of-the-money,” then the buyer won’t exercise it – to do so would be a money-losing proposition. A call option is out-of-the-money when the price of the underlying stock is lower than the strike price. A put option is out-of-the-money when the price of the underlying stock is above the strike price.