I understand what options are and how they can be used from a very basic perspective. I just don't understand how, when, and who can write an option contract? Can there be more than one put or call option for one underlying security? Do all options expire if not exercised, or traded, at regular intervals. If so, are the regular intervals company security specific or are they the same intervals for all companies underlying securities. When you buy a stock does it come with the ability to write a put, or do you need to double check? I would appreciate any input. I know these are very basic questions, but my financial knowledge has to begin somewhere. Your question indicates that you are asking about put and call options, which are a type of option contract for which there is public trading. Employee incentive (and non incentive )stock options are another type of option contract (essentially call options).
Not all companies with publicly traded securities have exchange listed put and call options. The companies themselves do not create the put and call options and are not responsible for them. The options are obligations of the Options Clearing Corporation, a kind of cooperative entity owned by securities trading firms, that guarantees the clearing of these securities. The option contracts are standardized agreements governing the terms of the security and the rights and obligations of the parties to the contract. Usually only companies with securities that are in high demand or volatile have option contracts that are listed on an exchange.
Options can be listed on the various security exchanges, usually the American Stock exchange and the Chicago Board of Options Exchange. The contract strike prices are usually determined by relation to the underlying stock price at the time the option is listed and by the rules of the option exchange. As the stock price changes, additional strike prices are added. The rules of the exchange also designate which expiration months that options may trade. The expiration months are on some type of cycle (like Jan, April, July and October), but as certain months roll off, additional near term months are added. There are also longer-term options, called LEAPS, which have expiration months as long as 2 years away. Because there are many strike prices for each option contract, there can be more options than the underlying securities. Each option covers 100 shares of the underlying stock.
"Writing" an option is selling an option. If you write a call option, it means that you give the holder of the option the right, but not the obligation, to purchase the underlying stock at the strike price by the expiration date. If a call option is exercised and you are the seller, you will have to deliver that stock. If you write a put option, the holder has right, but not the obligation, to sell that stock to you at the strike price by the expiration. For each option purchased, someone had to sell that option (the seller can be the specialist who makes the market in that option) Each option strike price has a bid and ask price. Anyone who has option trading authorization from their brokerage firm can buy or sell options. To get such authorization, you usually must demonstrate some experience and understanding of options as well as other financial/net worth considerations.
I do not believe there is a set number of option contracts per strike price.
There are two differnent types of settlement options -- American and European. I believe American settlement means that the option can only be exercised at expiration (usually the third Saturday of the month of expiration). U.S publicly traded options have American settlement. For European settlement, the option can be exercise at any time by the holder of the option. If an option is not exercised by expiration, it expires.
Not all stocks have publicly traded options, but some private parties may enter into option contracts for those with or without publicly traded options.
The Option Clearing Corporation has a website with more information about publicly traded options. You typically have to get approval from your broker to trade options, so you are aware of the risks. Stocks very rarely become completely worthless, or you can wait out a dip indefinitely. But options can expire worthless in a finite time if they are out of the money on their expiration date, so it is easy to lose your investment if you do not know what you are doing.
"Writing" an option means "selling" a call or put, which you can only do if someone is willing to buy it. Selling a call while you own the underlying stock is quite common because you have the stock to cover the call. But selling a call without stock or another purchased option with same expiration to cover it is very dangerous because loss could be unlimited. So a call with nothing to cover it is not allowed in a cash account.
Selling a put is not quite as dangerous because a stock cannot go below zero. But in a cash account, you can only do that if you have enough cash to put on hold to cover the strike price or difference in a put spread, in case it goes against you. You can still lose a significant amount of money if you guess wrong.
Not all stocks have options, so you should research first if the stock you are interested in has options and whether those options are liquid (enough "open interest" to trade if you want to get out of your position). Each stock, ETF, or index that has options will have various expiration times and strike prices. Some things that can throw you off track are stock pre-split or post-split, special dividends, or which versions of index options expire monthly or quarterly.
You should never invest everthing in options. Many people limit their option trades to 5 to 10% of their portfolio (and that is once they know what they are doing). |
