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The 6-Week Options Trading Kickstarter: What Are Options, and Why Should We Care About Them?

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Steve Smith breaks down the basics of options trading.

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If the call owner decides to purchase the underlying shares, we say that he is "exercising" his right to do so. If the call writer is forced to sell shares, he is being "assigned" his obligation.

A put option gives the buyer the right to sell shares at a specified strike price prior to the expiration date. And on the other side, the seller of a put option has the obligation to purchase shares at the strike price prior to the expiration date.

At any given time, most equity and ETF options offer a multitude of strike prices, which are typically in $5 increments (though options in some smaller stocks trade in $1 or $2.50 increments), and at minimum, four expiration dates throughout the year that occur on the third Friday of the month. Also, many different expiration periods -- such as quarterly, monthly, and even weekly options -- have been added to popular issues in recent years.

Unlike stocks, where each one has a finite number of shares to be traded, the options market can create an unlimited number of contracts. And whereas all shareholders can make or lose money depending on the price of a stock, the option market is a zero-sum game. For every dollar made in the option market, there is a dollar lost.

Options Come with Premiums

The cost of an option is usually referred to as its "premium." Back to our Apple September $600 call example: With shares of Apple at $605 on July 6, the call was priced at $35 per contract.

Given that the strike price is $5 below the current stock price, the call is said to have $5 of intrinsic value.

The other $30, which is comprised of time and implied volatility, is described as extrinsic value.
No positions in stocks mentioned.

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