Options Basics

An option contract gives the holder the right, but not the obligation, to buy/sell something at a predetermined date and price.

(1) There are two primary types of options: calls and puts.

- Call Options: Gives the buyer the right to buy a certain quantity of the underlying asset at a certain price within a certain period of time in the future until the expiration date

- Put Options: Gives the buyer the right to sell a certain quantity of the underlying asset at a certain price within a certain period of time in the future until the expiration date

(2) Key elements of options

Term	Definition
Underlying Asset	The security that you agree to buy or sell as stipulated by the Options Contract.
Exercise Time	The time at which the buyer can exercise their right as stipulated by the Options Contract
Strike Price	The price at which the Options Contract stipulates an asset can be bought or sold
Premium	Amount paid by the Options Buyer to buy the Options Contract
Exercise	Options buyer chooses to execute their right
Physical settlement	A manner of settling a derivative transaction under which physical delivery of the underlying or obligation is contemplated under the contract
Cash settlement	Options holder makes a direct profit based on the difference in price without actual physical delivery of the underlying

(3) Relationship between Options Strike Price and the price of the underlying asset

Direction	Relationship	Classification
Call Options	P > S	In-the-money
P < S	Out-of-the-money
P = S	At-the-money
Put Options	P > S	In-the-money
P < S	Out-of-the-money
P = S	At-the-money

S = Strike Price

P = Underlying asset Price

The Major Greeks

Greeks	Definition	Example
Delta	The change in its premium as a result of price changes in its underlying. Call options have positive deltas while put options have negative deltas.	If a call option has a price of $1 and a delta of 0.25, then the option’s price will move by 25% of the corresponding change in the underlying’s price.
Gamma	Speed at which delta changes. All options have positive gamma values.	If options A and B have the same delta values but option B has a higher gamma value. Then option B will have a greater degree of risk since it is more susceptible to price changes.
Theta	Quantifies the risk with a figure that represents a price drop for each day. All options have a negative theta value.	An option price at $5 with a theta of -0.25 will lose $0.25 daily.
Vega	Price sensitivity to implied volatility.	A call options purchased for $5 with an implied volatility of 25% and a vega of 0.2. If implied volatility increases by 3%, the new premium will be: option premium = $5 + (3 x 0.2) = $5.60