Option Basics for Investors
Who Don’t Trade Options

As an affluent investor, your portfolio may include mutual funds, index funds, separately managed accounts, and retirement accounts, some of which may hold options in their allocations.

In other words, you own options, too.

Many high-net-worth individuals and families like you likely prefer your assets to be managed by professional advisors and within professional portfolios. You are not an active options investor, and don’t want to be. However, you may want to understand what option terms mean, their features and benefits, and pros and cons. Option terminology is a baroque language of its own.

An option is a contract that represents the right to buy or sell a financial product at an agreed-upon price for a specific period of time. Investors can typically buy and sell an option contract any time before the contract expires. Investors can own options on stocks, ETFs and indexes.

Portfolio managers can use options trading to achieve three objectives—create income, protect against potential losses as a risk management tool, and provide leverage for extended growth. Investors can buy call options for a fraction of the underlying stock’s price.

This guide to option terminology includes 24 key terms to help you understand options.

Assignment

An assignment is the option contract seller’s contractual obligation to sell or buy an underlying stock at the exercise price. Assignments are activated when an option buyer exercises his right to buy or sell the underlying security.

At-the-Money

When an option investor is “at-the-money,” it means the option’s strike price is the same as the market price of the underlying stock.

Buyers

Options buyers can purchase either puts or calls. Option buyers receive the right, but not the obligation, to assume a future position. A call option buyer may profit if the underlying asset moves above the strike price before the expiration date. A put option buyer profits if the price falls below the strike price before expiration. Option buyers are also called holders.

Calls

The primary objective of a covered call strategy is to create steady income from stocks already owned. The call is “covered” by the underlying stock. Call options provide the buyer the right to purchase 100 shares of an underlying stock at a fixed price. Covered calls involve selling the option rather than buying it. When an investor sells a covered call, instead of paying a premium, he gets the premium. Investors typically buy calls when they expect the price of the underlying stock to go up.

Calendar Spreads

Investors who employ calendar spreads aim to generate a profit when an asset’s price remains relatively stable. Investors look to make money based on time decay, not on if a stock prices goes up or down. Tactically, investors buy an underlying asset with different delivery dates.

Collars

A collar is a fairly sophisticated strategy that may help investors diversify their portfolio and mitigate taxes. The tactic is to simultaneously buy covered calls and protective puts.

Derivatives

Options are part of an asset class called “derivative,.” because the option value “derived” from its underlying asset.

Expiration Date

An option not closed out by the expiration date expires. The expiration date is the last day on which an option can be exercised. Weekly options stop trading on Friday. Monthly stock options stop trading on the third Friday of each month and expire the next day. If the stock trades below the holder’s call price (or above the put strike price) at expiration, it expire worthless.

In-the-Money

An in-the-money call option means the option holder can buy the security below its current market price. An in-the-money put option means the option holder can sell the security above its current market price.

Intrinsic Value

The intrinsic value of an option is the amount of profit that can investors get in theory—if the option is exercised at that moment and the stock is either purchased (for calls) or sold (for puts) at the current market price.

Longs

When an investor is “long” an option it means she purchased it in an opening transaction to own or hold the option.

Out-of-the-Money

A call option is “OTM” when a stock’s underlying price trades below its strike price. A put option is OTM if the underlying’s price is above the put’s strike price.

Premium

A premium is the option’s price. Premiums are quoted per share.

Puts

Buying a put option is a bearish strategy. A put gives the buyer the right to sell 100 shares at a fixed price before its expiration date. The put option seller must buy the stock at the strike price if exercised. If the long put expires worthless, the entire cost of the put position is lost. Puts are typically bought when investors expect the underlying stock price to go down. Investors who seek to buy options at a discount may buy cash-secured puts. Protective puts (and protective calls) can help investors limit downside risk.

Sellers

The objective of selling options to a buyer is to receive a premium from the buyer. Option sellers are also called option writers. The seller is obligated to buy or sell the underlying asset if the buyer decides to exercise the option before the expiration date. See also option buyers.

Shorts

Investors who are short will sell options in an opening transaction. Shorts must be purchased later to close out the contract.

Straddles

The objective of a straddle strategy is to profit from large moves in the price of the underlying security and to limit the risk and amount of price declines. Investors simultaneously buy a call option and a put option with the same strike price and expiration date.

Strangles

Investors who use strangles seek to profit from big stock price movements either up or down. In a strangle, investors hold a call and a put option with the same maturity date, but with different strike prices. Strangles combine call option and put option features in one trade.

Strike Price

The strike price is the per share price at which investors can buy or sell puts or calls. If the stock price doesn’t go up and the buyer doesn’t exercise the option, the seller loses what they paid for the call. Investors must purchase the stock when it expires if the stock price goes over the strike price.

Time Decay.

The value of an option erodes to zero by expiration. This price erosion is called time decay.

Triple Witching Hour

The triple witching hour happens every third Friday in March, June, September, and December, when option contracts expire at the same time on the same day during the last sixty minutes of the trading day.

Underlying Asset

The underlying asset, which can be a stock, commodity, or index, is the asset the option allows investors to purchase or sell.

About Solidarity Capital

Solidarity Capital is a boutique asset management company and investment fund manager focused on delivering monthly income to investors using a proprietary investment strategy. Based in Lehi, Utah, Solidarity is led by our founders, Jimmy Mortimer, Jeff McClean, and Zach Whitchurch, entrepreneurial thinkers and doers.

About Jeff McClean

Jeff McClean, Managing Partner of Solidarity Capital, brings a unique perspective to the Solidarity Capital investment team. Jeff leads fundraising, fund administration, investor relations, product development, and contributes to the strategic investment direction of Solidarity Capital. He earned a bachelor’s degree in accounting from Brigham Young University–Idaho, and a Juris Doctor, with honors, from the University of Texas School of Law.