Before you jump into the deep end with options trading, there are a few key terms to understand.
First, as we noted last week, an option is a contract (a call and a put) that gives you the right—but never the obligation—to buy or sell a stock at a set price over a set time frame A call option, also known as a derivative, gives you the right to buy an asset at a set price over a set period. You would buy a call if you are bullish. A put option gives you the right to sell an asset at a set price over a set period. You would buy a put if you are bearish. Puts are similar to shorting a stock, because you are betting on the short side of stock.
Here are some more of the basics:
Options Expiration Dates
Other key terms to know include options expiration dates, which refer to the time frame you choose to hold an option for. For example, if you chose to buy to open the Apple (AAPL) August 20 145 call option, that option would expire by August 20, meaning it will no longer trade after that date. An options buyer can choose to close the option by or before August 20 for a gain or a loss, or let the option expire worthless.
Options Strike Prices
This is your goal price. For example, if you believe that Apple could hit $145 a share by an August 20, 2021 expiration date, you could buy to open an Apple call option contract with a strike price of $145.
In the Money (ITM), Out of the Money (OTM)
These are all terms that apply to an option’s strike price.
A call option is ITM when the underlying stock price is higher than the exercise price. A put option is ITM when the stock price is lower than the exercise price. In other words, an option is ITM when you can make money when exercising it.
By contrast, a call option is OTM when the underlying stock price is lower than the exercise price. A put option is OTM when the underlying stock price is higher than the exercise price.