at-the-money (ATM). If the stock price is below the strike price the call is
out-of-the-money (OTM). This relationship is just the opposite for puts. If
the stock price is below the strike price, the put is in-the-money. If the stock
price and the strike price are about the same, the put is at-the-money. And,
if the stock price is above the put strike, it is out-of-the-money.
Option Type
There are two types of options: calls and puts. Calls give the holder the
right to buy the underlying and the writer the obligation to sell the
underlying. Puts give the holder the right to sell the underlying and the
writer the obligation to buy the underlying.
Premium
The price of an option is called its premium. The premium of this option is
$5. Like stock prices, option premiums are stated in dollars and cents per
share. Since the option represents 100 shares of IBM, the buyer of this
option will pay $500 when the transaction occurs. Certain types of spreads
may be quoted in fractions of a penny.
An option’s premium is made up of two parts: intrinsic value and time
value. Intrinsic value is the amount by which the option is in-the-money.
For example, if IBM stock were trading at 171.30, this 170-strike call
would be in-the-money by 1.30. It has 1.30 of intrinsic value. The
remaining 3.70 of its $5 premium would be time value.
Options that are out-of-the-money have no intrinsic value. Their values
consist only of time premium. Sometimes options have no time value left.
Options that consist of only intrinsic value are trading at what traders call
parity . Time value is sometimes called premium over parity .
Exercise Style
One contract specification that is not specifically shown here is the exercise
style. There are two main exercise styles: American and European.
American-exercise options can be exercised, and therefore assigned,
anytime after the contract is entered into until either the trader closes the