Mechanics of the Options Market
8 important questions on Mechanics of the Options Market
What option positions exist?
- Long Call: max(S-K,0)
- Long Put: max(K-S,0)
- Short Call: min(K-S,0), writer of a call
- Short Put: min(S-K,0), writer of a put
What are potential underlying assets for options?
- Foreign currency options, OTC, usually 10.000 units of a currency (Yen: 1 mln)
- Index options, both OTC and exchange, S&P500, most European (except S&P100), settlement is in CASH (more convenient than selling the complete underlying)
- Futures options, on most futures contracts an option exist. Usually the maturity is a short period of time before expiration of the future. For a call that is exercised the gain is the excess of the futures price over the strike price.
What about the expiration date?
- Before expiration date: January, February, April, July
- After expiration date: February, March, April, July
Meaning that if trading for one month expires a new month comes in.
LEAP (Long-term Equity AnticiPation Securities), trade up to 39 month is the future.
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What about the strike price?
- Between 5 and 25 dollar it is 2.5
- Between 25 and 200 dollar it is 5
- More than 200 dollar it is 10
When a new expiration date is introduced the two or three closest strike prices are selected by the exchange. If it moves outside the range, a new strike option is usually introduced.
What about FLEX and nonstandard?
Nonstandard products, options on/like:
- ETF
- Weeklys (write on Thursday and expire Friday in a week)
- Binary options (pay-off $100 if price above strike, in case of a call)
- CEBO (credit event binary option), suffer credit event by maturity it will payoff
- DOOM options, deep out-of-the-money put options that are CDS like. Only payoff when the stock really plunges.
What about dividends and stock splits?
What about limits (position and exercise)?
An exercise limit is usually equal to the position limit. Maximum number of contracts that can be exercised in any period of 5 consecutive business days. Ranging from 250k to 25k, depending on capitalization and amount of shares.
What about regulation and taxation?
Taxation is tricky due to:
- Difference between capital gain and income
- If exercised rolled over into stock (put premium that is pay counts!)
- Wash Sale Rule: unrealized loss into realized and repurchase, not for 30 days
- Constructive sales, if "constructively sold" it is taxed.
- Note: buying in-the-money put option is not triggering!! It should eliminate gain and loss, both sides!
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