What Are Stock Options? - What Is A Stock Option?

http://www.optionsizzle.com What are Stock Options?

I was recently asked this question by a visitor to my web site,

You may have seen the term "stock options" in the financial section while scanning the news. Or perhaps, you've encountered the term as an employee and were offered stock options in your company. So, what are stock options? Can these options be used to your advantage? Yes! There are two different types of stock options. Let me help you understand the difference.

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What Are Stock Options -- Employee Stock Option (ESO)

An Employee Stock Option (ESO) is a type of non-cash compensation that is typically issued to management as part of an executive compensation package. Technically, an ESO is classified as a non-standardized option because it has several differences from an exchange traded option. The reason companies offer this type of compensation to management is because it provides management with incentive to run the business well. The stock of a well managed company with good growth potential is likely to rise, rewarding the management team.

Here are some differences between an ESO and an exchange traded option:

1) An ESO is may not be traded. That means that cannot be bought or sold in the open market on any kind of exchange. An ESO is strictly issued from the company to the employee.

2) The quantity of the ESO is determined by the company and is not standardized like an exchange traded option. The strike price or exercise price is usually the price of the company stock.

3) The duration of an ESO varies and it can be many years to expiration, unlike an exchange traded option that has a shorter life span to expiration.

What Are Stock Options -- Exchange Traded Options

An Exchange Traded Option is a standardized contract that is traded over the counter on a specific exchange. Standardized means that there is a standard set of rules governing the trading of that exchange traded option. These are the types of options that you will typically only have access to since they are traded on an exchange and available to the public.

1) Unlike an ESO, one standardized option contract represents one hundred shares. So if I bought one Apple (AAPL) option contract, I would actually control one hundred shares of that stock. If I decided to exercise that contract, then I would be purchasing one hundred shares of stock for every one option contract I exercised.

2) There are two types of standardized option contracts. You can be a buyer or a seller of an option and each gives you specific rights or obligations. To keep it simple in the example below, I will explain only the concept of buying the two types of options.

A call option gives you the right to buy the underlying asset (stock or future) at a set strike price. It is a right and not an obligation. You pay a premium or deposit for the option contract which gives you the right to own the stock at a set price on or before a set date. When you buy a call option, you expect the price of the underlying asset to go higher in order for the option contract to become profitable. What you have at risk is only the premium that you paid for the option contract. So, in the case of purchasing a home, you would put down a deposit to show the seller you were a serious buyer. If a few days later a tornado destroyed the house, you would lose only your deposit amount and not the full value of the home. I know there are probably ways to get your deposit back, but I wanted to give you a visual.

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What Are Stock Options? | What Is A Stock
Option?
What are Stock Options?
I was recently asked this question by a visitor
to my web site, www.optionsizzle.com.
You may have seen the term “stock options”
in the financial section while scanning the
news. Or perhaps, you’ve encountered the
term as an employee and were offered stock
options in your company. So, what are stock
options? Can these options be used to your
advantage? Yes! There are two different types
of stock options. Let me help you understand
the difference.
What Are Stock Options – Employee Stock
Option (ESO)
An Employee Stock Option (ESO) is a type of
non-cash compensation that is typically issued
to management as part of an executive compensation
package. Technically, an ESO is classified
as a non-standardized option because it has
several differences from an exchange traded
option. The reason companies offer this type
of compensation to management is because it
provides management with incentive to run
the business well. The stock of a well managed
company with good growth potential is likely
to rise, rewarding the management team.
Here are some differences between an ESO and
an exchange traded option:
1) An ESO may not be traded. That means that
cannot be bought or sold in the open market
on any kind of exchange. An ESO is strictly
issued from the company to the employee.
2) The quantity of the ESO is determined by
the company and is not standardized like an
exchange traded option. The strike price or
exercise price is usually the price of the
company stock.
3) The duration of an ESO varies and it can
be many years to expiration, unlike an exchange
traded option that has a shorter life span
to expiration.
What Are Stock Options – Exchange Traded
Options
An Exchange Traded Option is a standardized
contract that is traded over the counter on
a specific exchange. Standardized means that
there is a standard set of rules governing
the trading of that exchange traded option.
These are the types of options that you will
typically only have access to since they are
traded on an exchange and available to the
public.
1) Unlike an ESO, one standardized option
contract represents one hundred shares. So
if I bought one Apple (AAPL) option contract,
I would actually control one hundred shares
of that stock. If I decided to exercise that
contract, then I would be purchasing one hundred
shares of stock for every one option contract
I exercised.
2) There are two types of standardized option
contracts. You can be a buyer or a seller
of an option and each gives you specific rights
or obligations. To keep it simple in the example
below, I will explain only the concept of
buying the two types of options.
A call option gives you the right to buy the
underlying asset (stock or future) at a set
strike price. It is a right and not an obligation.
You pay a premium or deposit for the option
contract which gives you the right to own
the stock at a set price on or before a set
date. When you buy a call option, you expect
the price of the underlying asset to go higher
in order for the option contract to become
profitable. What you have at risk is only
the premium that you paid for the option contract.
So, in the case of purchasing a home, you
would put down a deposit to show the seller
you were a serious buyer. If a few days later
a tornado destroyed the house, you would lose
only your deposit amount and not the full
value of the home. I know there are probably
ways to get your deposit back, but I wanted
to give you a visual.
A put option gives you the right, but not
the obligation, to sell the underlying asset
(stock or future) at a set price on or before
a set date. You pay a premium or deposit to
own that right to sell. When you buy a put,
you want the value of the underlying asset
to go lower in order for you option to become
profitable. Buying a put option is referred
to as shorting the underlying asset. Many
refer to put options as insurance. Recall
the example above of the house destroyed by
the tornado. If you were the seller of that
house, then you would have paid an insurance
premium to recoup the full value of the intact
house and not the current, lower value of
the destroyed house.
The cost to you of rebuilding the house to
its former state is the insurance premium
you paid and nothing more.
3) An option contract has a determined expiration
date on which the option will expire. Option
buyers need to exercise (or sell) the stock
option before this date. An option which has
a long time to expiration is more expensive
than an option with a shorter expiration date.
4) An option contract has an agreed price
which is called the strike price. The strike
is the price at which buyers of call options
can buy the stock prior to expiration. It
is also the price at which buyers of put options
can sell the stock.
What Are Stock Options – My Tips
1) A stock option is usually bought at a significantly
lower price than the actual price of the underlying
asset, so you don’t have to put up as much
money to control the same amount of shares
as if you were buying the underlying asset.
This is one of the reasons why I use options
than the underlying asset.
2) Because of the tremendous amount of leverage
and the amount of shares you can control with
options, you have to be extra careful. There
are many components to the pricing of options.
Keep in mind that over ninety percent of option
contracts expire worthless so if you are thinking
of putting your entire account in one option
contract, then you might not have a account
in the future.
3) The market trend will usually dictate which
type of stock option to buy. If the market
is in an uptrend, you would look to buy calls.
Alternatively, if the market is in a downtrend,
then you would look to buy puts.
Trading stock options may sound complicated,
but it is much easier than it seems once you
master some basic terminology and techniques.
All the actual paperwork of the option contract
is handled through brokers and stock exchanges.
All you have to do is to consult with your
financial advisor on whether it’s a good
time to buy or to sell stock options. It is
important that you understand how the system
works, so that you manage your risk and don’t
incur great losses.
What Are Stock Options Conclusion:
There you go! I hope you enjoyed this article
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