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The Options Contract (With Examples)

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What Is An Options Contract?

By definition, an options contract is an agreement between two parties, the buyer, and the seller, where the option buyer has the right to buy or sell an option at an agreed price no later than the set date.

The price that has been set is known as the strike price and the time element of the agreement is known as the expiration date.

As we demystify options and options contract, the next logical question to ask is where are they used.

Options are used in all areas of finance, and they are found in securities, commodities and in real estate transactions.

Using the two classes of options (call options and put options), we are going to lay out some option contract examples for a put contact and a call contract that will show when we are going to exercise the contract and when we’ll let the contract expire.

The type of option used in the options trading example would be option used in the options trading example would be American options, which means the contract can be exercised on any day up to the expiration date.

There are two things to look out for with all options contracts, and these are the strike price and the expiration date. These two things along with today’s date and the current market value of the asset will determine what action to take.

Call Option Example

In this options contact example, Mr. Rawlings has a call option to buy 500 Pynpinie shares at $23 a share, making the strike price $23 and the option expiration date is 31st May.

When To Exercise A Call Option

With call options, you want to buy low and sell high before the option expires.

Here are three examples showing what action to take when looking at the share price alongside the strike price and the expiry date of an option.

Call Option Example One

The option is still in date. As the current market price for the shares is $30 and the strike price for the call option is $23, you would want to exercise the option as you would be paying a lower price for the shares than if you bought it on the open market.

This would mean the option is in the money.

Action to take – Exercise the option

Call Option Example Two

The option is still in date. If the current market price for the shares is $18 and the strike price for the call option is $23, you would not want to exercise the option as you would be paying a higher price for the shares by exercising the option.

In this instance, you would be better off buying the shares on the open market as the option would be out of the money.

Action to take – Do not exercise the option

Call Option Example Three

The option is out of date. If the current market price for the shares is $50 and the strike price for the call option is $23, you would not be able to exercise the option in this instance as the option is no longer in date.

The option is worthless.

Action to take – No action required.

Put Option Example

In this options contract example, Ms Farley has a put option to sell 350 Pynpinie shares at $35 a share, making the strike price $35 and the option expiration date is 30th November.

When To Exercise A Put Option

With put options, you want to sell as sell high before the option expires.

Here are three examples showing what action to take when looking at the share price alongside the strike price and the expiry date of the option.

Put Option Example One

The option is still in date. As the current market price for the shares is $28 and the strike price for the put option is $35, you would want to exercise the option as you would be selling the shares at a higher price than if you sold it on the open market.

This would mean the option is in the money.

Action to take – Exercise the option

Put Option Example Two

The option is still in date. As the current market price for the shares is $43 and the strike price for the put option is $35, you would not want to exercise the option as you would be selling the shares at a lower price than if you sold it on the open market.

This would mean the option is out of the money.

Action to take – Do not exercise the option

Put Option Example Three

The option is no longer in date. Even though the current market price for the shares is $11 and the strike price for the put option is $35, you would not be able to exercise the option as it has expired.

This would mean the option is now worthless.

Action to take – No action required.

Conclusion

The examples laid out here has given you a very brief overview option contracts that would help you understand when to exercise an option and when to let it expire. For a full explanation of what option contracts are, you can watch this video for more info:


Editor’s Note: You can get industry advice and examples if you head over to Jason Bond Picks. With programs such as the Millionaire Roadmap, you gain insight from trading experts in a mentoring program that will lead you to success.

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About Carol St. Amand

Carol St. Amand

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