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Equity Option Basics

Options involve risk and are not suitable for all investors.
Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.

Options are financial instruments that provide flexibility in almost any investment situation.
Options give you options by providing the ability to tailor your position to your situation.
  • You can hedge stock holdings from a decline in market price.
  • You can increase income against current stock holdings.
  • You can prepare to buy stock at a lower price.
  • You can position yourself for a big market move, even when you don't know which way prices will move.
  • You can benefit from a stock price's rise or fall without incurring the cost of buying the stock outright.

Describing Equity Options

  • An equity option is a contract that conveys to its holder the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) shares of the underlying security at a specified price (the strike price) on or before a given date (expiration day). After this given date, the option ceases to exist. The seller of an option is, in turn, obligated to sell (in the case of a call) or buy (in the case of a put) the shares to (or from) the buyer of the option at the specified price upon the buyer's request.
  • Equity option contracts usually represent 100 shares of the underlying stock.
  • Strike prices (or exercise prices) are the stated price per share for which the underlying security may be purchased (in the case of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract. Do not confuse the strike price, a fixed specification of an option contract, with the premium. Premium is the price at which the contract trades. This price fluctuates daily.
  • Equity option strike prices are listed in increments of .5, 1, 2.5, 5 or 10 points, depending on their price level.
  • Adjustments to an equity option contract's size, deliverable and/or strike price may be made to account for stock splits or mergers.
  • Generally, at any given time, you can purchase a particular equity option with one of at least four expiration dates.
  • Equity option holders do not enjoy the rights due stockholders (e.g., voting rights, regular cash or special dividends). A call holder must exercise the option and take ownership of underlying shares to be eligible for these rights.
  • Buyers and sellers set option prices in the exchange markets. All trading is conducted in the competitive manner of an auction market.

Calls and Puts

The two types of equity options are calls and puts.
A call option gives its holder the right to buy 100 shares of the underlying security at the strike price, any time before the option's expiration date. The writer (or seller) of the option has the obligation to sell the shares.
The opposite of a call option is a put option, which gives its holder the right to sell 100 shares of the underlying security at the strike price, any time before the option's expiration date. The writer (or seller) of the option has the obligation to buy the shares.
For illustrative purposes only.

The Options Premium

An option's price is called the premium. The option holder's potential loss is limited to the initial premium paid for the contract. Alternately, the writer has unlimited potential loss. This loss is somewhat offset by the initial premium received for the contract.
Investors can use put and call option contracts to take a position in a market using limited capital. The initial investment is limited to the price of the premium.
Investors can also use put and call option contracts to actively hedge against market risk. Investors can purchase a put as a hedge to protect a stock holding against an unfavorable market move while maintaining stock ownership.
A call option on an individual stock issue may be sold to provide a limited degree of downside protection in exchange for limited upside potential.

Underlying Security

The underlying security (such as XYZ Corporation) is the instrument that an option writer must deliver (in the case of call) or purchase (in the case of a put) upon assignment of an exercise notice by an option contract holder.

Expiration Friday

Most options that expire in a given month usually expire on the third Friday of the month. Therefore, this third Friday is the last trading day for all expiring equity options.
This day is called Expiration Friday. If the third Friday of the month is an exchange holiday, the last trading day is the Thursday immediately preceding this exchange holiday.
Many products now offer short-term options with weekly expirations, so investors should know the exact contract terms, including expiration dates, for all contracts they trade.
After the option's expiration date, the contract ceases to exist. At that point, the owner of the option who does not exercise the contract has no right and the seller has no obligations as previously conveyed by the contract.
Content licensed from the Options Industry Council is intended to educate investors about U.S. exchange-listed options issued by The Options Clearing Corporation, and shall not be construed as furnishing investment advice or being a recommendation, solicitation or offer to buy or sell any option or any other security. Options involve risk and are not suitable for all investors.

Content licensed from the Options Industry Council. All Rights Reserved. OIC or its affiliates shall not be responsible for content contained on Merrill's Website, or other Company Materials not provided by OIC. OIC education can be accessed at the OIC web site popup.

Without the Jargon

An equity option can represent a bullish, bearish, or neutral strategy. An equity option is issued as a call or a put which determines if the contract contains the right to buy (call) or the right to sell (put). Each contract represents 100 shares of the underlying security. The strike price represents the price at which the underlying security can be purchased or sold at. The expiration date determines how long the contract is in effect. The purchaser of an equity option has the right to execute upon the contract or sell to close the contract in the options market at any time until the expiration date. The price at which the contract is bought to open or sold to close upon is called the premium.
Information not provided by the Options Industry Council
Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.
View definitions for investment terms in our Glossary.
The material was provided by a third party not affiliated with Merrill or any of its affiliates and is for information and educational purposes only. The opinions and views expressed do not necessarily reflect the opinions and views of Merrill or any of its affiliates. Any assumptions, opinions and estimates are as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is in your best interest based on your particular circumstances and, if necessary, seek professional advice.
For purposes of all the computations discussed in this article, commissions, fees and margin interest and taxes, have not been included in the examples. These costs obviously will impact the outcome of any stock or option transaction. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Past performance is not a guarantee of future results.
This material is being provided for informational purposes only. Nothing herein is or should be construed as investment, legal or tax advice, a recommendation of any kind, a solicitation of clients, or an offer to sell or a solicitation of an offer to invest in options. The information herein has been obtained from third-party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed.

Supporting documentation for any claims, comparisons, recommendations, statistics or other technical data will be furnished on request.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
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Investing in securities involves risks, and there is always the potential of losing money when you invest in securities.

Asset allocation, diversification, and rebalancing do not ensure a profit or protect against loss in declining markets.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

This material is not intended as a recommendation, offer or solicitation for the purchase or sale of any security or investment strategy. Merrill offers a broad range of brokerage, investment advisory (including financial planning) and other services. Additional information is available in our Client Relationship Summary (PDF).

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