Contractual Rights and Obligations
The option buyer is the party who owns the right inherent in the contract.
The buyer is referred to as having a long position and may also be called the
holder, or owner, of the option. The right doesn’t last forever. At some point
the option will expire. At expiration, the owner may exercise the right or, if
the option has no value to the holder, let it expire without exercising it. But
he need not hold the option until expiration. Options are transferable—they
can be traded intraday in much the same way as stock is traded. Because it’s
uncertain what the underlying stock price of the option will be at expiration,
much of the time this right has value before it expires. The uncertainty of
stock prices, after all, is the raison d’être of the option market.
A long position in an option contract, however, is fundamentally different
from a long position in a stock. Owning corporate stock affords the
shareholder ownership rights, which may include the right to vote in
corporate affairs and the right to receive dividends. Owning an option
represents strictly the right either to buy the stock or to sell it, depending on
whether it’s a call or a put. Option holders do not receive dividends that
would be paid to the shareholders of the underlying stock, nor do they have
voting rights. The corporation has no knowledge of the parties to the option
contract. The contract is created by the buyer and seller of the option and
made available by being listed on an exchange.
The party to the contract who is referred to as the option seller, also called
the option writer, has a short position in the option. Instead of having a right
to take a position in the underlying stock, as the buyer does, the seller
incurs an obligation to potentially either buy or sell the stock. When a trader
who is long an option exercises, a trader with a short position gets assigned
. Assignment means the trader with the short option position is called on to
fulfill the obligation that was established when the contract was sold.
Shorting an option is fundamentally different from shorting a stock.
Corporations have a quantifiable number of outstanding shares available for
trading, which must be borrowed to create a short position, but establishing
a short position in an option does not require borrowing; the contract is
simply created. The strategy of shorting stock is implemented statistically