The first aspects of an option contract is the option’s quantity. The number of shares or contracts that can be obtained upon exercising an exchange-listed option contract is standardized. Each stock option contract allows the holder of that option to control 100 shares of the underlying security while each futures option contract can be exercised to obtain one contract in the underlying futures contract.
Futures are leveraged assets typically representing a large, standardized quantity of an underlying security which expire at some predetermined date in the future. Each futures option contract allows the holder to control the total number of units that comprise the futures contract until the option is liquidated, but no later than its expiration date.
Another item that identifies the option contract is the asset itself. The asset refers to the type of investment that can be obtained by the option holder. This asset could be a futures contract, shares of stock in a company, or a cash settlement in the case of an index contract.
The type of option is critical in determining the trader’s market outlook. Unlike trading stocks or futures themselves, option trading is not simply being long a particular market or short a particular market. Rather, there are two types of options, call options and put options, and two sides to each type, long or short, allowing the trader to take any of four possible positions. One can buy a call, sell a call, buy a put, sell a put, or any combination thereof. It is important to understand that trading call options is completely separate from trading put options. For every call buyer there is a call seller; while for every put buyer there is a put seller. Also keep in mind that option buyers have rights, while option sellers have obligations. For this reason, option buyers have a defined level of risk and option sellers have unlimited risk.
A call option is a standardized contract that gives the buyer the right, but not the obligation, to purchase a specific number of shares or contracts of an underlying security at the option’s strike prices, or exercise price, sometime before the expiration date of the contract. Buying a call contract is similar to taking a long position in the underlying asset, and one would purchase a call option if one believed that the market value of the asset was going appreciate before the date the option expires. The most trader can lose by purchasing a call option is simply the price that he or she pays for the option; the most the trader can make is unlimited.
On the other side of the transaction, the seller, or writer, of a call options has the obligation, not the right, to sell a specific number of shares or contracts of an asset to the option buyer at the strike price, if the option is exercised prior to its expiration date. Selling a call contract acts as a proxy for a short position in the underlying asset, and one would sell a call option if one expected that the market value of the asset would either decline or move sideways. (See Payoff Diagram)
