What is an Option - Part 3
...continued from Part 2
Theexpiration date is the last day an option exists. For listed stockoptions, this is the Saturday following the third Friday of theexpiration month. Please note that this is the deadline by whichbrokerage firms must submit exercise notices to OCC; however, theexchanges and brokerage firms have rules and procedures regardingdeadlines for an option holder to notify his brokerage firm of hisintention to exercise. This deadline, or expiration cut-off time, isgenerally on the third Friday of the month, before expiration Saturday,at some time after the close of the market.
Please contactyour brokerage firm for specific deadlines. The last day expiringequity options generally trade is also on the third Friday of themonth, before expiration Saturday. If that Friday is an exchangeholiday, the last trading day will be one day earlier, Thursday.
Withrespect to this section's usage of the word, long describes a position(in stock and/or options) in which you have purchased and own thatsecurity in your brokerage account.
For example, if you havepurchased the right to buy 100 shares of a stock, and are holding thatright in your account, you are long a call contract. If you havepurchased the right to sell 100 shares of a stock, and are holding thatright in your brokerage account, you are long a put contract. If youhave purchased 1,000 shares of stock and are holding that stock in yourbrokerage account, or elsewhere, you are long 1,000 shares of stock.When you are long an equity option contract:
- You have the right to exercise that option at any time prior to its expiration.
- Your potential loss is limited to the amount you paid for the option contract.
Withrespect to this section's usage of the word, short describes a positionin options in which you have written a contract (sold one that you didnot own). In return, you now have the obligations inherent in the termsof that option contract.
If the owner exercises the option,you have an obligation to meet. If you have sold the right to buy 100shares of a stock to someone else, you are short a call contract. Ifyou have sold the right to sell 100 shares of a stock to someone else,you are short a put contract. When you write an option contract youare, in a sense, creating it. The writer of an option collects andkeeps the premium received from its initial sale. When you are short(i.e., the writer of) an equity option contract:
- You can be assigned an exercise notice at any time during the life of the option contract. All option writers should be aware that assignment prior to expiration is a distinct possibility.
- Your potential loss on a short call is theoretically unlimited. For a put, the risk of loss is limited by the fact that the stock cannot fall below zero in price. Although technically limited, this potential loss could still be quite large if the underlying stock declines significantly in price.
Anopening transaction is one that adds to, or creates a new tradingposition. It can be either a purchase or a sale. With respect to anoption transaction, consider both:
- Opening purchase -- a transaction in which the purchaser's intention is to create or increase a long position in a given series of options.
- Opening sale -- a transaction in which the seller's intention is to create or increase a short position in a given series of options.
Aninvestor does not close out a long call position by purchasing a put,or vice versa. A closing transaction for an option involves thepurchase or sale of an option contract with the same terms, and on anyexchange where the option may be traded. An investor intending to closeout an option position must do so by the end of trading hours on theoption's last trading day.
- Closing purchase -- a transaction in which the purchaser's intention is to reduce or eliminate a short position in a given series of options. This transaction is frequently referred to as "covering" a short position.
- Closing sale -- a transaction in which the seller's intention is to reduce or eliminate a long position in a given series of options.
Continued in Part 4...
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