STOP: If you’re feeling frustrated, and locked out of the “make money” game, then learn what an Option is
An option is a traded security that is a derivative product.
By derivative product we suggest that it is a product whose cost is centred on the price of another. Since we are referring to stocks, a stock option is centred around a number of factors, not least the price of the underlying stock.
There are also options on other traded securities such as currencies, indexes and interest rates, but here we will limit our discussion to stock options, or options based on stocks.
A distinguishing factor of an option is that is a depreciating asset in the sense that it has a limited life, and has to be used before the date on which it expires. As time goes by, the option loses value as it moves closer to its expiration date
When we speak of options in terms of volume, we refer to contracts. Every stock option contract is the same as 100 shares of stock. When we focus on 2 contracts, we are actually focussing on 200 shares, 10 contracts; and so on. For example focussing on 1,000 shares, 75 contracts 7500 shares and so on.
NOTE: It is important to understand the dollar cost of options before actually trading them. When an option is quoted at $1.00 per contract, the trader must understand that the $1.00 signifies a price of $1.00 every share, not every contract. Do not forget that each and every contract is valued at 100 shares. This means if you were to purchase one option contract at a price of One Dollar.00, your total cost will be One Hundred Dollars.00 (1contract x$1.00 every share x 100 shares every contract). If you were to get 10 contracts for $1.50 each contract, your whole cost works out at $1500.00. Adopt the method below when working out the total dollar cost of the option.
Total Dollar Cost of Trade = Number of Contracts x Price per Contract x 100
Option contracts are literally a sales agreement between two parties. The two parties are the buyer (or holder) and the seller (or writer). When getting an option contract the owner is believed to be long the option. When you sell an option contract, you are judged to be short the option. This presumes you had no prior stake in the said option.
In an option contract, although it looks like the buyer and seller should be combined together, they in actual fact are not. So, do you understand that the buyer does not, in actual fact, buy from the seller and the seller does not, in reality, sell to the buyer.
In actuality, the Options Clearing Corporation (OCC) jumps in the middle of the two sides. The OCC gets it from the seller and gives it to the purchaser. This guarantees the OCC impartiality and, hence, means both the seller and the buyer can get out of a position without involving each other.
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