Part 2 Ride The Big Moves Key Option Terms
Understanding option trading requires familiarity with essential terms:
Underlying Asset: The security (stock, index, commodity, currency) on which an option is based.
Strike Price: The pre-decided price at which the underlying asset can be bought or sold.
Expiration Date: The date on which the option contract expires.
Premium: The price paid to purchase the option.
In-the-Money (ITM): Call options where the underlying price > strike price, and put options where the underlying price < strike price.
Out-of-the-Money (OTM): Call options where the underlying price < strike price, and put options where the underlying price > strike price.
At-the-Money (ATM): Strike price is equal or near the underlying asset’s price.
American vs European Options: American options can be exercised anytime before expiration; European options only on the expiration date.
Option Pricing
Option pricing is influenced by several factors. The Black-Scholes Model and Binomial Models are commonly used to calculate theoretical option prices. Major factors include:
Underlying Asset Price: Higher prices increase call option value and decrease put option value.
Strike Price: Determines profitability; the closer to the underlying price, the more valuable an option.
Time to Expiration: Longer duration generally increases option premiums due to higher uncertainty.
Volatility: Higher volatility increases the probability of profitable movements, raising option value.
Interest Rates: Affects the cost of carry and slightly influences options pricing.
Dividends: Expected dividends impact option value, especially for stocks.
