Understanding Option Prices
When seen for the first time, options prices can seem quite complex. The following illustrates how options are generally reported in newspapers or on screen.
- Type of OptionA call is the right to buy the stock, while a put is the right to sell the stock.
- PremiumThe price of an option is called its "premium." The potential loss to the buyer of an option can be no greater than the initial price paid for the contract, regardless of the performance of the underlying stock. This allows an investor to control the amount of risk assumed.
- Exercise (Strike) PriceThe price at which an option holder has the right to buy or sell the underlying share is known as its exercise price or strike price. This will generally be quoted in pence per share.
- Expiry DateAll options expire on a certain date, called the "expiry date." For the majority of equity options, this can be up to nine months from the date the options are first listed for trading.
- Underlying Share PriceThe price of the company's stock upon which the option contract is based.
The pricing of an option is directly related to the price of the underlying share. Other things equal, options attract higher premiums the longer they have until expiry and the more volatile the underlying share price.