The most common type of stock option is a call stock option. A call stock option gives the holder of the option the right, but not the obligation, to purchase the underlying share for a predetermined price, within a specific time frame. The opposite is a put stock option, a stock option that gives the holder a right, but not an obligation, to sell the underlying share, for a predetermined price, within a specific time frame.
If a company has issued different classes of shares, e.g. A stock and B stock, it is important to check the term sheet of the call stock option to learn which class of share the option gives you the right to purchase.
Important terminology for stock call options
- The price you pay when you purchase your stock call option is called premium.
- If you hold a call option on a stock, and use it to purchase the underlying share, this is known as exercising the stock option.
- The s strike price is the price you pay when you use your call option to buy the underlying share. It is the price you pay for the share.
Some call stock options are for more than one share, but the strike price will always be expressed per share. So, if you have a call stock option that gives you the right to purchase 50 shares in Exxon Mobil Corp. (XOM), the term sheet of your stock option will show the strike price for 1 share, not a lump sum for all 50 shares.
- The writer is the entity that created the stock call option and is obliged to honor it.
What is the time frame for exercising a stock option?
So, when can you exercise your stock option? That information is found in the term sheet for your stock option. Some stock options can only be exercised on a specific predetermined date, while others can be exercised on any date within a certain interval. There are also other more complex stock options available.
A European-style stock option can only be exercised on the expiration date. An American-style stock option can be exercised on any day until the stock option expires. Stock options that are neither European-style or American-style are known as exotic stock options. There is for instance the Bermuda-style stock option, an a option that can only be exercised on certain dates, e.g. on the 15th of January, April, July and October 2017. Bermuda-style stock options are quite unusual; the Bermuda-style is much more popular for certain options where the underlying is not stock.
The settlement terms are outlined in the term sheet for the call stock option. This is where you will be able to see if the writer of the option actually has to sell you the underlying share if you elect to exercise the option, or if the writer is allowed to pay you in cash instead of actually making your the owner of the underlying share.
Exchange listed stock options are typically settled through a clearinghouse, which means that the writer and the holder will not have any contact with each other.
Stock option trading
A majority of stock options are traded over-the-counter (OTC), but there is also a pretty large selection of stock options available for those who prefer to trade in exchange listed stock options. Exchange listed stock options are highly standardized contracts. Buying and selling stock options at an exchange means an added layer of security, just as when you trade stocks at an exchange instead of OTC – provided of course that the exchange is a trustworthy exchange. Most exchanges will assume responsibility for honoring the stock option if the writer does not honor the stock option. Also, stock options that are listed at an exchange are typically settled through a clearinghouse.
Other types of options
The stock option is probably the most famous type of option, but it is definitely not the only type of financial option available for speculators. You can for instance purchase commodity options, equity options, futures contracts options, bond options and other interest rate options, currency cross rate options, or warrants. Warrants aren’t exactly options, but they are in essence very similar to call stock options.