Basic Knowledge Of US Stock Options
Options Basics
What are stock options？
A stock option is a standardized contract with a stock as the underlying asset, thus it can be traded on an exchange and settled by a clearing house.
- Stock options can be divided into call options and put options according to the differences of rights between right owners;
- American options and European options according to the exercise method;
- Cash settlement and physical delivery according to the settlement method. Most U.S. stocks and HK stocks are American options based on physical delivery, while index options are generally European options based on cash settlement.
In terms of stock options, the buyer is the right owner while the seller is the obligation bearer.
- The buyer of an American call option has the right to buy the underlying stock at the strike price on or before the expiry date of the contract, and the seller of the call option is obliged to sell the underlying stock at the strike price if the option is exercised.
- The buyer of an American put option has the right to sell the underlying stock at the strike price on or before the expiry date of the contract, and the seller of the put option is obliged to buy the underlying stock at the strike price if the option is exercised.
A European option can only be exercised on the contract's expiry date.
| Call Option | Put Option | |
|---|---|---|
| Buyer | Right owner | Right owner |
| Buy the underlying stock on the expiry date | Sell the underlying stock on the expiry date | |
| Seller | Obligation bearer | Obligation bearer |
| Sell the underlying stock on the expiry date | Buy the underlying stock on the expiry date |
What is the option premium?
The option premium is the trading price of an option and the only variable in a standardized contract.
For options traded on an exchange, the price is displayed on a per-share basis, and the minimum trading contract is 1. Generally, 1 contract for U.S. stock options is 100 shares. The buyer (right owner) pays the option premium to receive the right and the seller (obligation bearer) charges option premium to fulfill the obligation.
Option premium = Option price x Contract size x Option multiplier
What is OTM/ITM？
- OTM - Out the Money
- ITM - In the Money
Every option has a strike price, so options can be divided into OTM & ITM according to the agreed strike price and the stock’s market price fluctuations. The difference between OTM and ITM is whether the option has real value at the moment.
How to determine the call option ITM/OTM: when the stock market price > the strike price, it is ITM, otherwise, it is OTM
How to determine the put option ITM/OTM: when the strike price > stock price, it is ITM, otherwise, it is OTM
An option is an ITM when it has real value.
When trading with Longbridge Securities, you can find that ITM/OTM options have distinct colors on the options chain page, and the blue part under the T-style layout is ITM options.
Four Basic P&L Calculations for Options Trading
Long call options
It gives the right to buy the underlying stock at the agreed price when it expires.
P&L Calculation
| Operation | P/L |
|---|---|
| Exercise | Profit = (stock market price - exercise price - option purchase price) * Qty |
| Waive | Lose options premium, which is the maximum loss |
For example:
Suppose a trader buys (Long) a call option (Call) at the option premium of USD 5, with a total payout of USD 500
Two elements:
Strike Price = 50
Contract Size = 100
The following situations will occur:
1. The stock market price is USD 40, and the stock market price < strike price USD 50
When the trader exercises the option, the P/L of each call option purchased = (40-50-5) * 100 = USD -1500. The maximum loss for waiving the exercise rights is the paid option premium of USD 500, which is lower than the loss for exercising the option. Therefore, most traders choose not to exercise.
2. The stock market price is USD 50, and the stock market price = strike price USD 50
When the trader exercises the option, the P/L of each call option purchased = (50-50-5) * 100 = USD -500. The maximum loss for waiving the exercise rights is the cost of the paid option premium of USD 500, which equals the option premium. Therefore, most traders choose not to exercise.
3. The stock market price is USD 60, and the stock market price = strike price USD 60
When the trader exercises the option, the P/L of each call option purchased = (60-50-5) * 100 = USD 500. The loss for waiving the exercise rights is the paid option premium of USD 500. Most traders choose to sell during the session, while a few choose to exercise the option to acquire the stock and sell the stock after delivery.
Long put options
It gives the right to sell the underlying stock at the agreed price when it expires.
P&L Calculation
| Operation | P/L |
|---|---|
| Exercise | Profit = (exercise price - stock market price - option purchase price) * Qty The minimum market price of the stock is 0, so it has the maximum return |
| Waive | Lose options premium, which is the maximum loss |
For example:
Suppose a trader buys (Long) a put option (Put) at the option premium of USD 5, with a total payout of USD 500
Two elements:
Strike Price = 50
Contract Size = 100
The following situations will occur:
1. The stock market price is USD 40, and the stock market price < strike price USD 50
When the trader exercises the option, the P/L of each put option purchased = (50-40-5) * 100 = USD 500. The trader will not gain the return if waiving the exercise rights and loss will be the paid option premium of USD 500. Most traders choose to sell during the session, while a few choose to exercise the option and sell the stock.
2. The stock market price is USD 50, and the stock market price = strike price USD 50
When the trader exercises the option, the P/L of each put option purchased = (50-50-5) * 100 = USD -500. The maximum loss for waiving the exercise rights is the cost of the paid option premium of USD 500, which equals the option premium. Therefore, most traders choose not to exercise.
3. The stock market price is USD 60, and the stock market price = strike price USD 60
When the trader exercises the option, the P/L of each put option purchased = (50-60-5) * 100 = USD -1500. The loss for waiving the exercise rights is the paid option premium of USD 500, which is lower than the loss for exercising the option. Therefore, most traders choose not to exercise.
Short call options
It stipulates the obligation to sell the underlying stock at the agreed price when it expires.
P&L Calculation
| Operation | P/L |
|---|---|
| Automatic exercise | ITM loss= (stock market price - exercise price - option purchase price) * Qty When the corresponding underlying stock is not held enough, the stock market price may rise infinitely, so there is the possibility of infinite loss |
| OTM automatic exercise may generate profit (very small probability) | |
| Automatically expires without being exercised | Receive options premium, which is the maximum profit |
For example:
Suppose a trader sells (Short) a call option (Call) at the option premium of USD 5, and gets the option premium of USD 500
Two elements:
Strike Price = 50
Contract Size = 100
The following situations will occur:
1. The stock market price is USD 40, and the stock market price < strike price USD 50
P/L of selling call options at the expiry date when being automatic exercised = [-max (40-50,0)+ 5)]*100. The trader is assigned a gain of USD 500 in the options contract on the exercise. In the OTM situations, there are very few cases where automatic exercise is assigned.
2. The stock market price is USD 50, and the stock market price = strike price USD 50
P/L of selling call options at the expiry date when being automatic exercised = [-max (50-50,0)+ 5)]*100. The trader is assigned a gain of USD 500 in the options contract on the exercise.
3. The stock market price is USD 60, and the stock market price = strike price USD 60
P/L of selling call options at the expiry date when being automatic exercised = [-max (60-50,0)+ 5)]*100. The trader is assigned a loss of USD 500 in the options contract on the exercise.
Short put options
It stipulates the obligation to buy the underlying stock at the agreed price when it expires.
P&L Calculation
| Operation | P/L |
|---|---|
| Automatic Exercise | ITM loss = (exercise price - stock market price - option purchase price) * Qty The limit loss is when the stock market price is 0 and therefore has the maximum loss |
| OTM automatic exercise may generate profit (very small probability) | |
| Automatically expires without being exercised | Receive options premium, which is the maximum profit |
For example:
Suppose a trader sells (Short) a put option (Put) at the option premium of USD 5, and gets the option premium of USD 500
Two elements:
Strike Price = 50
Contract Size = 100
The following situations will occur:
1. The stock market price is USD 40, and the stock market price < strike price USD 50
P/L of selling put options at the expiry date when being automatic exercised = [-max (50-40,0) + 5) ]*100. After the trader is assigned to automatic exercise, they obtain 100 shares of the underlying stock at the exercise price of USD 50. If the market price remains unchanged, the obtained stock will lose USD 1000, and the option earn USD 500. The balance is USD -500.
2. The stock market price is USD 50, and the stock market price = strike price USD 50
P/L of selling put options at the expiry date when being automatic exercised = [-max (50-50,0) + 5) ]*100. After the trader is assigned to automatic exercise, they obtain 100 shares of the underlying stock at the exercise price of USD 50. If the market price remains unchanged, they can earn the options return of USD 500.
3. The stock market price is USD 60, and the stock market price = strike price USD 60
P/L of selling put options at the expiry date when being automatic exercised = [-max (50-60,0) + 5) ]*100. After the trader is assigned to automatic exercise, they obtain 100 shares of the underlying stock at the exercise price of USD 50. If the market price remains unchanged, they can earn the options return of USD 500. Rarely will the buyer exercise the option in this situation.
Options Trading FAQs
How to trade options?
Enter the options chain page in the stock details page, tap the corresponding option, activate the quick trade drawer, select buy or sell, enter the corresponding price and quantity to place an order.
What are the supported order types for options?
Currently, options trading supports limit orders、 market orders 、conditional orders and long-term orders.
What is the minimum trading unit for options?
An option is a standardized contract with a minimum trading volume of 1 unit. Generally, 1 contract unit equals 100 shares (corporate actions may result in 1 option not being equal to 100 shares).
For example, in the case of options contract SPY 220304 C 429000, its options premium is USD 6.68. Therefore, a total of $ 6.68 * 100 = $ 668 needs to be paid for holding this option. Upon exercise, 100 shares of SPY will be received.
What are the trading hours for options?
The trading hours for U.S. stock options are 9:30～16:00 EST
Daylight saving time (March - November). The above time corresponds to 21:30 - 04:00 (GMT+8)
Standard time (November - next March). The above time corresponds to 22:30-05:00 (GMT+8)
Note: Most U.S. stock options do not support pre&post-market trading, but some ETF and ETN options can be extended until 16:15 EST.
Why is the margin requirement higher for close-to-expiry options?
A close-to-expiry option refers to an option that will expire within the trading day, and if the option becomes ITM or close to the execution price at 11:00-14:00 EST, margin requirements will raise.
An option may become an ITM and be exercised on the expiry date. If a user does not have enough funds and underlying stocks required for exercise, their account may become “dangerous” and generate a margin call. Therefore, if the margin rises and a margin call occurs, users can liquidate their options position, transfer to other positions, or deposit to eliminate the margin call.
Exercise & Settlement
Exercise Instructions
If a client still holds an options position after the option expires, Longbridge will “exercise the option” or “waive the exercise rights” on the user’s behalf. At the same time, the client does not be able to voluntarily exercise the option or voluntarily waive the exercise of rights.
Exercise
ITM options are exercised before the market opens on the next trading day.
- Call options: If strike price < underlying stocks’ settlement price, then they are ITM options.
- Put options: If strike price > underlying stocks’ settlement price, then they are ITM options.
After exercising the option:
- Long Call / Short Put: When the option is exercised, you have to buy the underlying stock at the strike price specified in the option contract. The quantity of the underlying stock you buy is determined by multiplying the option's exercise unit by 100. At the same time, the option will be expired.
- Long Put / Short Call: When the option is exercised, you have to sell the underlying stock at the strike price specified in the option contract. The quantity of the underlying stock you sell is determined by multiplying the option's exercise unit by 100. At the same time, the option will be expired. If you do not hold a sufficient number of shares of the underlying stock, it may result in a short selling position.
Waive
OTM options will be waived before the market opens on the next trading day.
- Call options: If strike price > underlying stocks’ settlement price, then they are OTM options.
- Put options: If strike price < underlying stocks’ settlement price, then they are OTM options.
After waving the exercise rights:
The user’s position will be null and void for either call options or put options.
Settlement
Options are settled on the T+1 day, and their underlying stocks are settled on the T+1 day.
Corporate Actions & Special Situations
In the case of corporate actions and other special situations, the user's current positions will be transferred to a new position, where the option value will not change, but the underlying stock corresponding to the option may change.
For example, 1 unit of BABA option corresponds to 100 shares of BABA underlying stock. If BABA issues a reverse stock split, 1 new share for 5 old shares, then the equity of each option equals 20 shares of BABA after consolidation, and the entire equity value does not change.
New positions, as a result of corporate actions, can be closed but not opened.