8.1 Options Basics & Contract Specifications
Options are derivative contracts giving the buyer the right, and the seller the obligation, to transact 100 shares at a fixed strike price before expiration.
Key FINRA Exam Takeaways
- 1 equity option contract universally controls 100 shares of underlying stock.
- Buyer (Holder): Pays premium, acquires a RIGHT to buy (Call) or sell (Put). Long position.
- Seller (Writer): Receives premium, assumes an OBLIGATION to sell (Call) or buy (Put). Short position.
- Expiration: Standard equity options expire on the third Friday of the expiration month at 11:59 PM ET.
- In-the-money (ITM) options have Intrinsic Value. Premium = Intrinsic Value + Time Value.
Calls vs. Puts: The Rights and Obligations Matrix
Long Call: Right to BUY stock at strike price. Short Call: Obligation to SELL stock at strike. Long Put: Right to SELL stock at strike price. Short Put: Obligation to BUY stock at strike.
Intrinsic Value vs. Time Value
Call Intrinsic Value = Market Price - Strike Price (if > 0). Put Intrinsic Value = Strike Price - Market Price (if > 0). Out-of-the-money options have ZERO intrinsic value. Any premium paid for an OTM option is 100% Time Value.
Intrinsic Value & Time Value Breakdown
XYZ stock is trading at $54. An XYZ Oct 50 Call trades for a premium of $5.50. What are the intrinsic value and time value per share?
- Step 1: Calculate Intrinsic Value for Call = Current Market Price ($54) - Strike Price ($50) = $4.00 (In-the-Money by $4).
- Step 2: Calculate Time Value = Premium ($5.50) - Intrinsic Value ($4.00) = $1.50.
- Step 3: Total contract premium = $5.50 × 100 = $550 ($400 intrinsic + $150 time value).
Stock ABC is trading in the market at $42. An ABC Nov 45 Put is trading at a premium of $4.50. What is the intrinsic value and time value of this put contract?