Options

Options (also known as derivatives) are contracts that give the buyer (owner, holder, etc.) the right to buy or sell an asset at a certain strike price on a specific date. Options are used for income to temper risk.

The "premium" is the dollar amount that a buyer pays to a writer for the right to purchase or sell a specified quantity of the underlying security, at a specified price, for a specific time period.

The main difference between stocks and options is that while stocks can give you a small piece of a company (ownership), options are just contracts that indicate your right to buy or sell the stock a certain price on a specific date.

When you are an options holder, the main risk for you is the entire amount of your paid premium. However, as an options writer, the risk is much higher because you would potentially face unlimited loss due to the lack of stock price caps.

The purchaser of an opening position in an options contract is called the "buyer" or "holder." The buyer is also said to be "long" the option or have a "long position" in the option. The buyer pays a premium in order to buy the option, which gives them a right that they can exercise during the life of the contract.

The investor who sells the contract to open is called the "seller" or "writer." The writer is also said to be "short" the option or have a "short position" in the option and is obliged to perform if/when the holder exercises his right. The writer receives a premium for writing the option, as compensation for the obligation they have taken on.

The most familiar options are those issued on common stock. These are known as "equity options." 

However, there are two different types of option contracts: a “Call” and a “Put.”

Calls are contracts that give you the right to buy 100 shares (usually) of a specific stock (the "underlying" security) from the option writer at a specific and fixed price (the "exercise" or "strike" price) at any time up to the expiration date.

Puts are contracts that give you the right to sell 100 shares (usually) of a specific stock to the put writer at any time up to the expiration date. When you write a put, you accept the obligation of buying that stock from the put buyer at the strike price at any time at the buyer's discretion up to the expiration date.

In order to upgrade your account to start trading options, you can apply to have your registered and non-registered accounts enabled for options traders by submitting the following forms:

Cash Accounts:

1. Margin and Short Margin Account Application form
2. Option Account Approval form
3. Personal and regulatory information update form

Registered Accounts:

1. Option Account Approval form
2. Personal and Regulatory Information Update form

Once completed, mail your original documents to:

Scotia iTRADE
P.0. Box 4002 Station A,
Toronto, On
M5W 0G4

American-style option
An option contract that can be exercised at any time between the date of purchase and the expiration date. Most exchange-traded options are American style.

Assignment
The receipt of an exercise notice by an options writer that requires him to sell (in the case of a call) or purchase (in the case of a put) the underlying security at the specified strike price.

At the money
An option is at-the-money if the strike price of the option is equal to the market price of the underlying security. For example, if xyz stock is trading at 54, then the xyz 54 option is at-the-money.

Call option
An option contract that gives the holder of the option the right (but not the obligation) to purchase, and obligates the writer to sell, a specified number of shares of the underlying stock at the given strike price, on or before the expiration date of the contract.

Closing purchase
A transaction in which the purchaser's intention is to reduce or eliminate a short position in a stock, or in a given series of options.

Closing sale
A transaction in which the seller's intention is to reduce or eliminate his long position in a stock, or a given series of options.

Covered call
A short call option position in which the writer owns the number of shares of the underlying stock represented by the option contracts. Covered calls generally limit the risk the writer takes because the stock does not have to be bought at the market price, if the holder of that option decides to exercise it.

Covered put
A put option position in which the option writer also is short the corresponding stock or has deposited, in a cash account, cash or cash equivalents equal to the exercise price of the option. This limits the option writer's risk because money or stock is already set aside. In the event that the holder of the put option decides to exercise the option, the writer's risk is more limited than it would be on an uncovered or naked put option.

Equity Options
Securities that give the holder the right to buy or sell a specified number of shares of stock, at a specified price for a certain (limited) time period. Typically one option equals 100 shares of stock.

European-style option
An option contract that can only be exercised on the expiration date.

Exercise
To implement the right of the holder of an option to buy (in the case of a call) or sell (in the case of a put) the underlying security.

Expiration cycle
An expiration cycle relates to the dates on which options on a particular security expire. As an example, a given option may be placed in 1 of 3 cycles; the January cycle, the February cycle, or the March cycle. At any point in time, an option may have contracts with 4 expiration dates outstanding, 2 in near-term months and 2 in far-term months.

Expiration date
The last day (in the case of American-style) or the only day (in the case of European- style) on which an option may be exercised. For stock options, this date is the Saturday immediately following the 3d Friday of the expiration month; however, brokerage firms may set an earlier deadline for notification of an option holder's intention to exercise. If Friday is a holiday, the last trading day will be the preceding Thursday.

In-the-money
A "call" option is in-the-money if the strike price is less than the market price of the underlying security. A "put" option is in-the-money if the strike price is greater than the market price of the underlying security. For example, an xyz "call" option with a 52 strike price is in-the-money when xyz trades at 52.01 or higher. An xyz "put" option with a 52 strike price is in-the-money when xyz is trading at 51.99 or lower.

Margin requirement (options)
The amount of cash an uncovered (naked) option writer is required to deposit and maintain to cover his daily position valuation and reasonably foreseeable intra- day price changes.

Opening purchase
A transaction in which the purchaser's intention is to create or increase a long position in a given series of options.

Opening sale
A transaction in which the seller's intention is to create or increase a short position in a given series of options.

Option
Gives the buyer the right, but not the obligation, to buy or sell stock at a set price on or before a given date. Investors, not companies, issue options. Investors who purchase call options expect the stock will be worth more than the price set by the option (the strike price), plus the price they paid for the option itself. Buyers of put options expect the stock's price will go down below the price set by the option.

Out of the money
A call option is out-of-the-money if the strike price is greater than the market price of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of the underlying security.

Premium
The price of an option contract, determined on the exchange, which the buyer of the option pays to the option writer for the rights to the option contract.

Put option
An option contract that gives the holder the right to sell (or "put"), and places upon the writer the obligation to purchase, a specified number of shares of the underlying stock at the given strike price on or before the expiration date of the contract.

Strike price
The stated price per share for which underlying stock may be purchased (in the case of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract.

Uncovered call
A short call option position in which the writer does not own shares of underlying stock represented by his option contracts. Also called a "naked" call, it is much riskier for the writer than a covered call, where the writer owns the underlying stock. If the buyer of a call exercises the option to call, the writer would be forced to buy the stock at market price.

Uncovered put
A short put option position in which the writer does not have a corresponding short stock position or has not deposited, in a cash account, cash or cash equivalents equal to the exercise value of the put. Also called "naked" puts, the writer has pledged to buy the stock at a certain price if the buyer of the options chooses to exercise it. The risk is limited to the value of the stock that the writer must purchase in the event that the option is exercised.

Underlying security
Options: the security subject to being purchased or sold upon exercise of an option contract. For example, IBM stock is the underlying security to IBM options. Depositary receipts: The class, series and number of the foreign shares represented by the depository receipt.