Premium is the actual cost of the option that the buyer of the option pays to the seller of the option. In some cases, the option may have both intrinsic value and time value.
Expiration is the last day to either exercise the option or to close out one’s option position. For most ordinary options, this expiration occurs on the third Saturday of every month, with the third Friday being the last trading day for options.
Open Interest is simply described as the number of open buy orders. If Person A buys 5 options from Person B, the open interest is 5. In addition, if Person C buys 10 options from Person D, the open interest is now 15. If Person A sells 3 options and Person D buys them, the new open interest is 12. In essence, Person A has close his position by 3 by having an offsetting transaction with Person D. If Person E buys 5 contracts from Person C, the open interest remains at 12 because Person C has an offsetting transaction of 5 while Person E establishes a new position. There is no net change in the number of open buy orders.
Options are a type of derivative investment that allows one to either leverage or hedge assets. The main type of option available in the United States is an American Option. An American Option is different from a European Option, in that one can choose when to exercise the option. Whether there is 3 days left in an option or 3 months, the holder of an American Option can choose when to exercise, give the option is “in-the-money”. With an European Option, one can only exercise the option at the expiration date. As we will see later, if we have an American Option that is “in-the-money,” we will want to hold onto the option as long as possible.
Before we continue, there are some terminology we must review. When trading American Options, one must be familiar with the terms Stock/Market Price, Strike/Exercise Price, Premium, Expiration, Open Interest, Call Option, Put Option, Buyer/Long, Seller/Short.
The Stock or Market price is just that. It is the current trading price for the underlying stock.
The Strike Price is the price where the option must be in order for the option to have any intrinsic value. From Wikipedia, it is also, “The fixed price at which the owner of an option can purchase, in the case of a call, or sell, in the case of a put, the underlying security or commodity.” This term is generally abbreviated with the letter X.
