Learn about Options

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.

The maximum loss, gain and breakeven of any options strategy only remains as defined so long as the strategy contains all original positions. Trading, rolling, assignment, or exercise of any portion of the strategy will result in a new maximum loss, gain and breakeven calculation, which will be materially different from the calculation when the strategy remains intact with all of the contemplated legs or positions. This is applicable to all options strategies inclusive of long options, short options and spreads.

Early assignment risk is always present for option writers (specific to American-style options only). Early assignment risk maybe amplified in the event a call writer is short an option during the period the underlying security has an ex-dividend date. This is referred to as dividend risk.

Long options are exercised and short options are assigned. Note that American-style options can be assigned/exercised at any time through the day of expiration without prior notice. Options can be assigned/exercised after market close on expiration day. View specific Merrill Option Exercise & Assignment Practices (PDF).

Supporting documentation for any claims, comparison, recommendations, statistics, or other technical data, will be supplied upon request.

Why do investors trade options?

Options can be complex and are traded for a variety of reasons. Option traders can use options in multiple ways to carry out a speculative, hedging or income investment objective. In each example below we show some of the many ways that each of these strategies could be carried out.

Speculation

Traders can take both sides of the market, trading on both the upward or downward movement of a stock or index.
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Hedging their Investments

Investors can hedge their holdings by using options to protect against directional risk.
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Generating Income

Investors can sell options against shares they own, giving up upside gains in favor of generating income.
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2:10
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Speculation

Traders can take both sides of the market, trading on both the upward or downward movement of a stock or index.
 Video 1 of 3 selected
2:11
Previous video Next video

Hedging their Investments

Investors can hedge their holdings by using options to protect against directional risk.
 Video 2 of 3
2:04
Previous video Next video

Generating Income

Investors can sell options against shares they own, giving up upside gains in favor of generating income.
 Video 3 of 3
2:10
 Video 1 of 3 selected  Video 2 of 3  Video 3 of 3
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What are options, and how do they work?

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What are the different types of options?

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The Greeks

Often people refer to the Delta, Theta, Gamma, Vega and Rho of their options' positions. These are known as the "Greeks." By better understanding the Greeks, investors can gain insight as to how an option's price may behave under a variety of conditions and external factors.
Read more about  Delta  selected Read more about  Theta Read more about  Gamma Read more about  Vega Read more about  Rho

Delta  content selected

How does the price of my options contract change if the price of the underlying stock or fund changes?

Delta is the theoretical estimate of how much an option's value may change given a $1 move UP or DOWN in the underlying security. The Delta values range from -1 to +1, with 0 representing an option where the premium barely moves relative to price changes in the underlying stock.
The Delta value range of -1 to +1, with put strategies on the left in red and call strategies on the right in green.
For illustrative purposes only.
Delta helps us measure the sensitivity of an option to its underlying stock price.
A chart shows a call with a higher delta moves more than a call with a lower delta if the underlying stock price increases.
For illustrative purposes only.
Select to close help pop-up The amount by which an option is in‑the‑money.
Select to close help pop-up A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in‑the‑money if the strike price is greater than the market price of the underlying security.

The Short Answer

An increasing Delta is an indication that the option is becoming more sensitive to the underlying security and ultimately the premium is comprised of mostly intrinsic value Select to open or close help pop-upThe amount by which an option is in‑the‑money.. For this reason, Delta can be used to assess the market-assigned probability of the option being in‑the‑money Select to open or close help pop-upA call option is in the money if the strike price is less than the market price of the underlying security. A put option is in‑the‑money if the strike price is greater than the market price of the underlying security. at expiration.
Read more about Delta

Theta  content selected

How does the price of my option decay over time?

Theta represents, in theory, how much an option's premium may decay each day with all other factors remaining the same.
Select to close help pop-up The amount of the option premium that is attributable to the amount of time remaining until the expiration of the option contract.
Select to close help pop-up An option is near the money when the strike price is relatively close to the market price.
Options lose value over time. The moment that the contract is created, time value Select to open or close help pop-upThe amount of the option premium that is attributable to the amount of time remaining until the expiration of the option contract. begins to deplete. The loss in time value of near-the-money Select to open or close help pop-upAn option is near the money when the strike price is relatively close to the market price. options accelerates as the expiration date approaches. This is a representation of Theta's behaving in a nonlinear fashion.
A line chart shows Theta, with option value decreasing more quickly with time until it reaches $0 on the day of expiration.
For illustrative purposes only.
A scale showing the buyer on the heavier side and the seller on the lighter side.
For illustrative purposes only.
Buyer Beware:
Since options are decaying in value, time favors the seller. The buyer needs extreme price movement to tip the scales.

The Short Answer

Theta is an important Greek to understand — options are a decaying asset, and Theta measures that decay. Buying an option means time is working against you, slowly eating away the value of your option. Higher Theta is indicative of a higher rate of decay.
Read more about Theta

Gamma  content selected

How does the rate of change of an option's Delta affect my options contract?

Gamma represents the rate of change between an option's Delta and the underlying asset's price. Higher Gamma values indicate that Delta could change dramatically with even very small price changes in the underlying stock or fund.
Select to close help pop-up An option is at the money if the strike price of the option is equal to the market price of the underlying security.
Select to close help pop-up A call option is out of the money if the strike price is greater than the market price of the underlying security. A put option is out of the money if the strike price is less than the market price of the underlying security.
Select to close help pop-up A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in‑the‑money if the strike price is greater than the market price of the underlying security.
At-the-money options Select to open or close help pop-upAn option is at the money if the strike price of the option is equal to the market price of the underlying security. options have the highest Gamma because their Deltas are more sensitive to underlying price changes. Gamma falls as the option moves out-of-the-money Select to open or close help pop-upA call option is out of the money if the strike price is greater than the market price of the underlying security. A put option is out of the money if the strike price is less than the market price of the underlying security. or in‑the‑money Select to open or close help pop-upA call option is in the money if the strike price is less than the market price of the underlying security. A put option is in‑the‑money if the strike price is greater than the market price of the underlying security..
A graph shows Gamma increases as an option gets closer to the strike price and decreases as it moves more into the money.
For illustrative purposes only.

The Short Answer

Gamma can be used to measure the stability or the instability of Delta. A higher Gamma is an indication of a greater potential change in Delta which equates to an instability of Delta. Essentially, when utilizing Delta for the probability of being in‑the‑money at expiration, Gamma can help determine the stability of the probability Delta provides.
Read more about Gamma

Vega  content selected

How much does a change in implied volatility affect my options price?

Vega measures the amount of increase or decrease in an option premium based on a 1% change in implied volatility. Implied volatility is defined as the market's forecast of a likely movement in the underlying security.
Select to close help pop-up An option is at the money if the strike price of the option is equal to the market price of the underlying security.
Select to close help pop-up A call option is out of the money if the strike price is greater than the market price of the underlying security. A put option is out of the money if the strike price is less than the market price of the underlying security.
Select to close help pop-up A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in‑the‑money if the strike price is greater than the market price of the underlying security.
The longer an option contract has until it expires, the more volatility affects the price. Vega falls as the option gets closer to expiration and increases as the underlying moves closer to the strike. In other words, Vega is centered around at‑the‑money Select to open or close help pop-upAn option is at the money if the strike price of the option is equal to the market price of the underlying security. options and falls as it moves out-of-the-money Select to open or close help pop-upA call option is out of the money if the strike price is greater than the market price of the underlying security. A put option is out of the money if the strike price is less than the market price of the underlying security. or in‑the‑money Select to open or close help pop-upA call option is in the money if the strike price is less than the market price of the underlying security. A put option is in‑the‑money if the strike price is greater than the market price of the underlying security..
A graph shows options with more days to expire will see a greater increase in Vega as the underlying nears the strike price.
For illustrative purposes only.
Vega and implied volatility can change without any movement from the underlying security.

The Short Answer

Options tend to be more expensive when implied volatility is higher because of the increased range of potential movement. Thus, whenever implied volatility goes up, the price of the option goes up.
Read more about Vega

Rho  content selected

How do interest rates affect the value of my options contract?

Rho is a measure of an option's sensitivity to changes in the risk-free rate of interest (the interest paid on US Treasury Bills) and is expressed as the amount of money an option will lose or gain with a 1% change in interest rates.
Rho is positive for long calls (right to buy) and increases with the price of the stock. Rho is negative for long puts (right to sell) and approaches zero as the stock price increases. Rho is positive for short puts (obligation to buy), and negative for short calls (obligation to sell).
A graph shows Rho calls increase above $0 and Rho puts increase from a negative value towards $0 as stock price increases.
For illustrative purposes only.

The Short Answer

Interest rate risk has the greatest effect on longer dated options and is present mainly when holding cash in an interest bearing account is more advantageous. Mainly a concern for LEAPS® options (options with greater than 1 year until expiration).
Read more about Rho
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.

The maximum loss, gain and breakeven of any options strategy only remains as defined so long as the strategy contains all original positions. Trading, rolling, assignment, or exercise of any portion of the strategy will result in a new maximum loss, gain and breakeven calculation, which will be materially different from the calculation when the strategy remains intact with all of the contemplated legs or positions. This is applicable to all options strategies inclusive of long options, short options and spreads.

Early assignment risk is always present for option writers (specific to American-style options only). Early assignment risk maybe amplified in the event a call writer is short an option during the period the underlying security has an ex-dividend date. This is referred to as dividend risk.

Long options are exercised and short options are assigned. Note that American-style options can be assigned/exercised at any time through the day of expiration without prior notice. Options can be assigned/exercised after market close on expiration day. View specific Merrill Option Exercise & Assignment Practices (PDF).

Supporting documentation for any claims, comparison, recommendations, statistics, or other technical data, will be supplied upon request.
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.
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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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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