How Options Work (Part 2)

How Options Work (Part 2)

Once you own an option, you have 3 different ways to exit it. You can exercise it, sell it, or let it expire worthless. By exercising an option you have purchased, you are choosing to fulfill the options contract. If you bought a call option and you exercise it you will be buying stock at the agreed upon price (Strike price). If you bought a put option and you exercise your put you will be selling stock at the agreed upon price (Strike Price). Only option buyers have the choice to exercise an option. Option sellers, on the other hand, are required to sell stock to a call option buyer who chooses to exercise their contract. Put option sellers are required to buy stock from put option buyers who wish to exercise their contracts.Selling your option, sometimes known as offsetting, is a method of reversing the original transaction to exit the trade. If you bought a call, you have to sell the call with the same strike price and expiration. If you sold a call, you have to buy a call with the same strike price and expiration. If you bought a put, you have to sell a put with the same strike price and expiration. If you sold a put you have to buy a put with the same strike price and expiration. Although you may not be selling your original option trade back to the same exchange, you will have an offsetting order as you account will show a buy and sell trade on the same stock, strike price and expiration month. If you do not offset your position, then you have not officially exited the trade.If an option has not been offset or exercised by expiration, the option expires worthless. If you originally sold an option, then you want it to expire worthless because you then get to keep the credit you received from the option premium without having to fulfill any part of the option contract. Since an option seller wants an option to expire worthless, the passage of time is an option seller's friend and an option buyer's enemy. For instance, If you sold a call on a stock in which you did not own, you would want the call to expire worthless so that you would not be required to sell someone stock that you do not own. You would like for the option to expire with the stock trading under the strike price of the option you sold. If you sold someone the right to buy a stock from you at 30.00 and the stock closed on expiration Friday at 28.00 you would not have to worry about someone exercising their options contract to call you out of the stock. If you bought an option, the premium is nonrefundable even if you let the option expire worthless. As an option gets closer to expiration, it decreases in value.It is important to note that most options traded on U.S. exchanges are American style options. These differ from European options in one main way. American style options can be exercised at any time up until expiration (4:00pm Eastern on the third Friday of the expiration month). In contrast, European style options can be exercised only on the day they expire. All the options of one type (put or call), which have the same underlying security, are called a class of options. For example, all the calls on IBM constitute an option class. All the options that are in one class and have the same strike price are called an option series. For example, all IBM calls with a strike price of 130 (and various expiration dates) constitute an option series.