T a b l e o f C o n t e n t sIntroduction 3

Benefits of Exchange-Traded Options 5■ Orderly, Efficient, and Liquid Markets■ Flexibility■ Leverage■ Limited Risk for Buyer■ Guaranteed Contract Performance

Options Compared to Common Stocks 8

What is an Option? 9■ Underlying Security■ Strike Price■ Premium■ American, European and Capped Styles■ The Option Contract■ Exercising the Option■ The Expiration Process

LEAPS®/Long-Term Options 14

The Pricing of Options 15■ Underlying Stock Price■ Time Remaining Until Expiration■ Volatility■ Dividends■ Interest Rates■ Understanding Option Premium Tables

Basic Strategies 18Buying Calls 18■ to participate in upward price movements■ as part of an investment plan■ to lock in a stock purchase price■ to hedge short stock sales

Buying Puts 23■ to participate in downward price movements■ to protect a long stock position■ to protect an unrealized profit in long stock

Selling Calls 28■ covered call writing■ uncovered call writing

Selling Puts 33■ covered put writing■ uncovered put writing

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IntroductionOptions are financial instruments that can provideyou, the individual investor, with the flexibility youneed in almost any investment situation you mightencounter.

Options give you options. You’re not just lim-ited to buying, selling or staying out of the market.With options, you can tailor your position to yourown situation and stock market outlook. Considerthe following potential benefits of options:

■ You can protect stock holdings from a declinein market price

■ You can increase income against current stock holdings

■ You can prepare to buy stock at a lower price■ You can position yourself for a big market

move — even when you don’t know whichway prices will move

■ You can benefit from a stock price’s rise or fallwithout incurring the cost of buying or sellingthe stock outright

A stock option is a contract which conveys to itsholder the right, but not the obligation, to buy orsell shares of the underlying security at a specifiedprice on or before a given date. After this givendate, the option ceases to exist. The seller of anoption is, in turn, obligated to sell (or buy) theshares to (or from) the buyer of the option at thespecified price upon the buyer’s request.

Options are currently traded on the followingU.S. exchanges: The American Stock Exchange,L.L.C. (AMEX), the Chicago Board OptionsExchange, Inc. (CBOE), the InternationalSecurities Exchange L.L.C. (ISE), the PacificExchange, Inc. (PCX), and the Philadelphia StockExchange, Inc. (PHLX). Like trading in stocks,option trading is regulated by the Securities andExchange Commission (SEC).

Conclusion 35

Glossary 36

Appendix: Expiration Cycle Tables 41

For More Information 43

This publication discusses exchange-traded options issued byThe Options Clearing Corporation. No statement in thispublication is to be construed as a recommendation to pur-chase or sell a security, or to provide investment advice.Options involve risks and are not suitable for all investors.Prior to buying or selling an option, a person must receive acopy of Characteristics and Risks of Standardized Options.Copies of this document may be obtained from your brokeror from any of the exchanges on which options are traded. Aprospectus, which discusses the role of The OptionsClearing Corporation, is also available without charge uponrequest addressed to The Options Clearing Corporation,440 S. LaSalle St., Suite 908, Chicago, IL 60605, or to anyexchange on which options are traded.

June, 2000

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Benefits of Exchange-Traded OptionsOrderly, Efficient, and Liquid Markets…Flexi-bility…Leverage…Limited Risk…GuaranteedContract Performance. These are the major benefitsof options traded on securities exchanges today.

Although the history of options extends sev-eral centuries, it was not until 1973 that standard-ized, exchange-listed and government-regulatedoptions became available. In only a few years, theseoptions virtually displaced the limited trading inover-the-counter options and became an indispens-able tool for the securities industry.

Orderly, Efficient and Liquid Markets

Standardized option contracts provide orderly, effi-cient, and liquid option markets. Except under spe-cial circumstances, all stock option contracts are for100 shares of the underlying stock. The strike priceof an option is the specified share price at which theshares of stock will be bought or sold if the buyer ofan option, or the holder, exercises his option. Strikeprices are listed in increments of 21⁄2, 5, or 10points, depending on the market price of the under-lying security, and only strike prices a few levelsabove and below the current market price are trad-ed. Other than for long-term options, or LEAPS®,which are discussed below, at any given time a par-ticular option can be bought with one of four expi-ration dates (see tables in Appendix). As a result ofthis standardization, option prices can be obtainedquickly and easily at any time during trading hours.Additionally, closing option prices (premiums) forexchange-traded options are published daily inmany newspapers. Option prices are set by buyersand sellers on the exchange floor where all trading isconducted in the open, competitive manner of anauction market.

The purpose of this booklet is to provide anintroductory understanding of stock options andhow they can be used. Options are also traded onindexes (AMEX, CBOE, PHLX, PCX), on U.S.Treasury rates (CBOE), and on foreign currencies(PHLX); information on these option products isnot included in this booklet but can be obtained bycontacting the appropriate exchange (see pages 43and 44 for addresses and phone numbers). Theseexchanges seek to provide competitive, liquid, andorderly markets for the purchase and sale of stan-dardized options. All option contracts traded onU.S. securities exchanges are issued, guaranteed andcleared by The Options Clearing Corporation(OCC). OCC is a registered clearing corporationwith the SEC and has received a ‘AAA’ rating fromStandard & Poor’s Corporation. The ‘AAA’ ratingrelates to OCC’s ability to fulfill its obligations ascounterparty for options trades.

This introductory booklet should be read inconjunction with the basic option disclosure docu-ment, titled Characteristics and Risks of StandardizedOptions, which outlines the purposes and risks ofoption transactions. Despite their many benefits,options are not suitable for all investors. Individualsshould not enter into option transactions until theyhave read and understood the risk disclosure docu-ment which can be obtained from their broker, anyof the options exchanges, or OCC. It must be notedthat, despite the efforts of each exchange to provideliquid markets, under certain conditions it may bedifficult or impossible to liquidate an option posi-tion. Please refer to the disclosure document for fur-ther discussion on this matter. In addition, marginrequirements, transaction and commission costs, andtax ramifications of buying or selling options shouldbe discussed thoroughly with a broker and/or taxadvisor before engaging in option transactions.

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however, that as an option buyer, the most you canlose is the premium amount you paid for the option.

Limited Risk for Buyer

Unlike other investments where the risks may haveno limit, options offer a known risk to buyers. Anoption buyer absolutely cannot lose more than theprice of the option, the premium. Because the rightto buy or sell the underlying security at a specificprice expires on a given date, the option will expireworthless if the conditions for profitable exercise orsale of the contract are not met by the expirationdate. An uncovered option seller (sometimes referredto as the uncovered writer of an option), on theother hand, may face unlimited risk.

Guaranteed Contract Performance

An option holder is able to look to the system creat-ed by OCC’s Rules – which includes the brokersand Clearing Members involved in a particularoption transaction and to certain funds held byOCC – rather than to any particular option writerfor performance. Prior to the existence of optionexchanges and OCC, an option holder who wantedto exercise an option depended on the ethical andfinancial integrity of the writer or his brokerage firmfor performance. Furthermore, there was no conve-nient means of closing out one’s position prior tothe expiration of the contract.

OCC, as the common clearing entity for allexchange traded option transactions, resolves thesedifficulties. Once OCC is satisfied that there arematching orders from a buyer and a seller, it seversthe link between the parties. In effect, OCC becomesthe buyer to the seller and the seller to the buyer. As aresult, the seller can buy back the same option he haswritten, closing out the initial transaction and termi-nating his obligation to deliver the underlying stock orexercise value of the option to OCC, and this will inno way affect the right of the original buyer to sell,hold or exercise his option. All premium and settle-ment payments are made to and paid by OCC.

Flexibility

Options are an extremely versatile investment tool.Because of their unique risk/reward structure,options can be used in many combinations withother option contracts and/or other financial instru-ments to create either a hedged or speculative posi-tion. Some basic strategies are described in a latersection of this booklet.

Leverage

A stock option allows you to fix the price, for a spe-cific period of time, at which you can purchase orsell 100 shares of stock for a premium (price) whichis only a percentage of what you would pay to ownthe stock outright. That leverage means that byusing options you may be able to increase yourpotential benefit from a stock’s price movements.

For example, to own 100 shares of a stock trad-ing at $50 per share would cost $5,000. On the otherhand, owning a $5 call option with a strike price of$50 would give you the right to buy 100 shares of thesame stock at any time during the life of the optionand would cost only $500. Remember that premiumsare quoted on a per share basis; thus a $5 premiumrepresents a premium payment of $5 x 100, or $500,per option contract. Let’s assume that one monthafter the option was purchased, the stock price hasrisen to $55. The gain on the stock investment is$500, or 10%. However, for the same $5 increase inthe stock price, the call option premium mightincrease to $7, for a return of $200, or 40%. Althoughthe dollar amount gained on the stock investment isgreater than the option investment, the percentagereturn is much greater with options than with stock.

Leverage also has downside implications. Ifthe stock does not rise as anticipated or falls duringthe life of the option, leverage will magnify theinvestment’s percentage loss. For instance, if in theabove example the stock had instead fallen to $40,the loss on the stock investment would be $1,000(or 20%). For this $10 decrease in stock price, thecall option premium might decrease to $2 resultingin a loss of $300 (or 60%). You should take note,

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unlike shares of common stock, the number of out-standing options (commonly referred to as “openinterest”) depends solely on the number of buyersand sellers interested in receiving and conferringthese rights.■ Unlike stocks which have certificates evidencingtheir ownership, options are certificateless. Optionpositions are indicated on printed statements pre-pared by a buyer’s or seller’s brokerage firm.Certificateless trading, an innovation of the optionmarkets, sharply reduces paperwork and delays.■ Finally, while stock ownership provides the hold-er with a share of the company, certain voting rightsand rights to dividends (if any), option owners par-ticipate only in the potential benefit of the stock’sprice movement.

What Is an Option?A stock option is a contract which conveys to itsholder the right, but not the obligation, to buy orsell shares of the underlying security at a specifiedprice on or before a given date. This right is grantedby the seller of the option.

There are two types of options, calls and puts.A call option gives its holder the right to buy anunderlying security, whereas a put option conveysthe right to sell an underlying security. For example,an American-style XYZ Corp. May 60 call entitlesthe buyer to purchase 100 shares of XYZ Corp.common stock at $60 per share at any time prior tothe option’s expiration date in May. Likewise, anAmerican-style XYZ Corp. May 60 put entitles thebuyer to sell 100 shares of XYZ Corp. commonstock at $60 per share at any time prior to theoption’s expiration date in May.

Options Compared to Common StocksOptions share many similarities with commonstocks:■ Both options and stocks are listed securities.Orders to buy and sell options are handled throughbrokers in the same way as orders to buy and sellstocks. Listed option orders are executed on thetrading floors of national SEC-regulated exchangeswhere all trading is conducted in an open, competi-tive auction market.■ Like stocks, options trade with buyers makingbids and sellers making offers. In stocks, those bidsand offers are for shares of stock. In options, thebids and offers are for the right to buy or sell 100shares (per option contract) of the underlying stockat a given price per share for a given period of time.■ Option investors, like stock investors, have theability to follow price movements, trading volumeand other pertinent information day by day or evenminute by minute. The buyer or seller of an optioncan quickly learn the price at which his order hasbeen executed.

Despite being quite similar, there are alsosome important differences between options andcommon stocks which should be noted:■ Unlike common stock, an option has a limitedlife. Common stock can be held indefinitely in thehope that its value may increase, while every optionhas an expiration date. If an option is not closed outor exercised prior to its expiration date, it ceases toexist as a financial instrument. For this reason, anoption is considered a “wasting asset.”■ There is not a fixed number of options, as there iswith common stock shares available. An option issimply a contract involving a buyer willing to pay aprice to obtain certain rights and a seller willing togrant these rights in return for the price. Thus,

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option has a strike price that is greater than the cur-rent market price of the underlying security, it is alsosaid to be in-the-money because the holder of this puthas the right to sell the stock at a price which isgreater than the price he would receive selling thestock in the stock market. The converse of in-the-money is, not surprisingly, out-of-the-money. If thestrike price equals the current market price, theoption is said to be at-the-money.

Premium

Option buyers pay a price for the right to buy or sellthe underlying security. This price is called theoption premium. The premium is paid to the writer,or seller, of the option. In return, the writer of a calloption is obligated to deliver the underlying security(in return for the strike price per share) to a calloption buyer if the call is exercised. Likewise, thewriter of a put option is obligated to take delivery ofthe underlying security (at a cost of the strike priceper share) from a put option buyer if the put is exer-cised. Whether or not an option is ever exercised,the writer keeps the premium. Premiums are quotedon a per share basis. Thus, a premium of 7⁄8 repre-sents a premium payment of $87.50 per option con-tract ($0.875 x 100 shares).

American, European and Capped Styles

There are three styles of options: American,European and Capped. In the case of an Americanoption, the holder of an option has the right to exer-cise his option on or before the expiration date of theoption; otherwise, the option will expire worthlessand cease to exist as a financial instrument. At thepresent time, all exchange-traded stock options areAmerican-style. A European option is an optionwhich can only be exercised during a specified periodof time prior to its expiration. A Capped option givesthe holder the right to exercise that option only dur-ing a specified period of time prior to its expiration,unless the option reaches the cap value prior to expi-ration, in which case the option is automatically

Underlying Security

The specific stock on which an option contract isbased is commonly referred to as the underlyingsecurity. Options are categorized as derivative secu-rities because their value is derived in part from thevalue and characteristics of the underlying security.A stock option contract’s unit of trade is the num-ber of shares of underlying stock which are repre-sented by that option. Generally speaking, stockoptions have a unit of trade of 100 shares. Thismeans that one option contract represents the rightto buy or sell 100 shares of the underlying security.

Strike Price

The strike price, or exercise price, of an option is thespecified share price at which the shares of stock canbe bought or sold by the holder, or buyer, of theoption contract if he exercises his right against awriter, or seller, of the option. To exercise youroption is to exercise your right to buy (in the case ofa call) or sell (in the case of a put) the underlyingshares at the specified strike price of the option.

The strike price for an option is initially set ata price which is reasonably close to the current shareprice of the underlying security. Additional or sub-sequent strike prices are set at the following inter-vals: 21⁄2-points when the strike price to be set is$25 or less; 5-points when the strike price to be setis over $25 through $200; and 10-points when thestrike price to be set is over $200. New strike pricesare introduced when the price of the underlyingsecurity rises to the highest, or falls to the lowest,strike price currently available. The strike price, afixed specification of an option contract, should notbe confused with the premium, the price at whichthe contract trades, which fluctuates daily.

If the strike price of a call option is less thanthe current market price of the underlying security,the call is said to be in-the-money because the holderof this call has the right to buy the stock at a pricewhich is less than the price he would have to pay tobuy the stock in the stock market. Likewise, if a put

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accepting exercise instructions from customers, andthose cut-off times may be different for differentclasses of options.

Upon receipt of an exercise notice, OCC willthen assign this exercise notice to one or moreClearing Members with short positions in the sameseries in accordance with its established procedures.The Clearing Member will, in turn, assign one ormore of its customers (either randomly or on a firstin first out basis) who hold short positions in thatseries. The assigned Clearing Member will then beobligated to sell (in the case of a call) or buy (in thecase of a put) the underlying shares of stock at thespecified strike price. OCC then arranges with astock clearing corporation designated by theClearing Member of the holder who exercises theoption for delivery of shares of stock (in the case ofa call) or delivery of the settlement amount (in thecase of a put) to be made through the facilities of acorrespondent clearing corporation.

The Expiration Process

A stock option usually begins trading about eightmonths before its expiration date. The exception isLEAPS® or long-term options, discussed below.However, as a result of the sequential nature of theexpiration cycles, some options have a life of onlyone to two months. A stock option trades on one ofthree expiration cycles. At any given time, an optioncan be bought or sold with one of four expirationdates as designated in the expiration cycle tableswhich can be found in the Appendix.

The expiration date is the last day an optionexists. For listed stock options, this is the Saturdayfollowing the third Friday of the expiration month.Please note that this is the deadline by which bro-kerage firms must submit exercise notices to OCC;however, the exchanges and brokerage firms haverules and procedures regarding deadlines for anoption holder to notify his brokerage firm of hisintention to exercise. Please contact your broker forspecific deadlines.

exercised. The holder or writer of either style ofoption can close out his position at any time simplyby making an offsetting, or closing, transaction. Aclosing transaction is a transaction in which, at somepoint prior to expiration, the buyer of an optionmakes an offsetting sale of an identical option, or thewriter of an option makes an offsetting purchase ofan identical option. A closing transaction cancels outan investor’s previous position as the holder or writerof the option.

The Option Contract

An option contract is defined by the following ele-ments: type (put or call), style (American, Europeanand Capped), underlying security, unit of trade(number of shares), strike price, and expiration date.All option contracts that are of the same type andstyle and cover the same underlying security arereferred to as a class of options. All options of thesame class that also have the same unit of trade atthe same strike price and expiration date are referredto as an option series.

If a person’s interest in a particular series ofoptions is as a net holder (that is, if the number ofcontracts bought exceeds the number of contractssold), then this person is said to have a long positionin the series. Likewise, if a person’s interest in a par-ticular series of options is as a net writer (if thenumber of contracts sold exceeds the number ofcontracts bought), he is said to have a short positionin the series.

Exercising the Option

If the holder of an option decides to exercise hisright to buy (in the case of a call) or to sell (in thecase of a put) the underlying shares of stock, theholder must direct his broker to submit an exercisenotice to OCC. In order to ensure that an option isexercised on a particular day, the holder must notifyhis broker before the broker’s cut-off time foraccepting exercise instructions on that day.Different firms may have different cut-off times for

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longer term view of the stock market. An initialLEAPS® position does not require an investor tomanage each position daily. Purchase of LEAPS®

puts provides a hedge for stock owners against sub-stantial declines in their stocks. Current optionsusers will also find LEAPS® appealing if they desireto take a longer term position of up to three years insome of the same options they currently trade.

Like other stock options, the expiration datefor LEAPS® is the Saturday following the thirdFriday of the expiration month. All equity LEAPS®

expire in January.

The Pricing of OptionsThere are several factors which contribute value toan option contract and thereby influence the premi-um or price at which it is traded. The most impor-tant of these factors are the price of the underlyingstock, time remaining until expiration, the volatilityof the underlying stock price, cash dividends, andinterest rates.

Underlying Stock Price

The value of an option depends heavily upon theprice of its underlying stock. As previouslyexplained, if the price of the stock is above a calloption’s strike price, the call option is said to be in-the-money. Likewise, if the stock price is below a putoption’s strike price, the put option is in-the-money. The difference between an in-the-moneyoption’s strike price and the current market price ofa share of its underlying security is referred to as theoption’s intrinsic value. Only in-the-money optionshave intrinsic value.

For example, if a call option’s strike price is $45and the underlying shares are trading at $60, theoption has intrinsic value of $15 because the holder

OCC has developed a procedure known asExercise By Exception to expedite its processing ofexercises of expiring options by certain brokeragefirms that are Clearing Members of OCC. Underthis procedure, which is sometimes referred to as“ex-by-ex”, OCC has established in-the-moneythresholds and every contract at or above its in-the-money threshold will be exercised unless OCC’sClearing Member specifically instructs OCC to thecontrary. Conversely, a contract under its in-the-money threshold will not be exercised unless OCC’sClearing Member specifically instructs OCC to doso. OCC does have discretion as to which securitiesare subject to, and may exclude other securities from,the ex-by-ex procedure. You should also note that ex-by-ex is not intended to dictate which customer positionsshould or should not be exercised and that ex-by-ex doesnot relieve a holder of his obligation to tender an exercisenotice to his firm if the holder desires to exercise hisoption. Thus, most firms require their customers to notifythe firm of the customer’s intention to exercise even if anoption is in-the-money. You should ask your firm toexplain its exercise procedures including any deadline thefirm may have for exercise instructions on the last trad-ing day before expiration.

LEAPS®/Long-Term OptionsLong-term Equity AnticiPation Securities®

(LEAPS®)/long-term stock options provide theowner the right to purchase or sell shares of a stock ata specified price on or before a given date up to threeyears in the future. As with other options, LEAPS®

are available in two types, calls and puts. Like otherexchange-traded stock options, LEAPS® areAmerican-style options.

LEAPS® calls provide an opportunity to ben-efit from a stock price increase without making anoutright stock purchase for those investors with a

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Dividends

Regular cash dividends are paid to the stock owner.Therefore, cash dividends affect option premiumsthrough their effect on the underlying share price.Because the stock price is expected to fall by theamount of the cash dividend, higher cash dividendstend to imply lower call premiums and higher putpremiums.

Options customarily reflect the influences ofstock dividends (e.g., additional shares of stock) andstock splits because the number of shares represent-ed by each option is adjusted to take these changesinto consideration.

Interest Rates

Historically, higher interest rates have tended toresult in higher call premiums and lower putpremiums.

Understanding Option Premium Tables

Premiums (prices) for exchange-traded options arepublished daily in a large number of newspapers. Atypical newspaper listing looks as follows:

In this example, the out-of-the-money XYZ July 115calls closed at 31⁄2, or $350 per contract, while XYZstock closed at 1123⁄8. The in-the-money July 120puts closed at 83⁄4, or $875 per contract.

of that option could exercise the option and buy theshares at $45. The buyer could then immediately sellthese shares on the stock market for $60, yielding aprofit of $15 per share, or $1,500 per option contract.

When the underlying share price is equal tothe strike price, the option (either call or put) is at-the-money. An option which is not in-the-money orat-the-money is said to be out-of-the-money. An at-the-money or out-of-the-money option has nointrinsic value, but this does not mean it can beobtained at no cost. There are other factors whichgive options value and therefore affect the premiumat which they are traded. Together, these factors aretermed time value. The primary components of timevalue are time remaining until expiration, volatility,dividends, and interest rates. Time value is theamount by which the option premium exceeds theintrinsic value.

Option Premium = Intrinsic Value + Time Value

For in-the-money options, the time value is theexcess portion over intrinsic value. For at-the-money and out-of-the-money options, the timevalue is the total option premium.

Time Remaining Until Expiration

Generally, the longer the time remaining until anoption’s expiration date, the higher the option pre-mium because there is a greater possibility that theunderlying share price might move so as to makethe option in-the-money. Time value drops rapidlyin the last several weeks of an option’s life.

Volatility

Volatility is the propensity of the underlying securi-ty’s market price to fluctuate either up or down.Therefore, volatility of the underlying share priceinfluences the option premium. The higher thevolatility of the stock, the higher the premiumbecause there is, again, a greater possibility that theoption will move in-the-money.

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Option & StrikeNY Close Price May Jun Jul May Jun Jul

XYZ 105 71⁄2 91⁄4 101⁄81⁄4

5⁄8 11⁄8

1123⁄8 110 3 43⁄4 61⁄4 13⁄16 17⁄8 25⁄8

1123⁄8 115 13⁄16 21⁄8 31⁄2 4 45⁄8 51123⁄8 120 3⁄16

7⁄8 13⁄4 81⁄8 83⁄8 83⁄4

1123⁄8 125 1⁄16 s 13⁄16 r s r1123⁄8 130 s s 3⁄8 s s 183⁄4

1) stock identification 4) closing option prices2) stock closing price 5) option expiration months3) option strike prices r = not traded s = no option listed

5

1 3 4

2

Calls-Last Puts-Last

1) You can exercise your option and buy the under-lying XYZ stock for $50 a share for a total costof $5,350 (including the option premium) andsimultaneously sell the shares on the stock mar-ket for $5,500 yielding a net profit of $150.

2) You can close out your position by selling theoption contract for $550, collecting the differ-ence between the premium received and paid,$200. In this case, you make a profit of 57%(200/350), whereas your profit on an outrightstock purchase, given the same price movement,would be only 10%.

The profitability of similar examples will dependon how the time remaining until expiration affectsthe premium. Remember, time value declinessharply as an option nears its expiration date. Alsoinfluencing your decision will be your desire to ownthe stock.

If the price of XYZ instead fell to $45 and theoption premium fell to 7⁄8, you could sell your optionto partially offset the premium you paid. Otherwise,the option would expire worthless and your losswould be the total amount of the premium paid or$350. In most cases, the loss on the option would beless than what you would have lost had you boughtthe underlying shares out-right, $262.50 on theoption versus $500 on the stock in this example.

Basic StrategiesThe versatility of options stems from the variety ofstrategies available to the investor. Some of themore basic uses of options are explained in the fol-lowing examples. For more detailed explanations,contact your broker or any of the exchanges.

For purposes of illustration, commission andtransaction costs, tax considerations and the costsinvolved in margin accounts have been omitted fromthe examples in this booklet. These factors will affect astrategy’s potential outcome, so always check with yourbroker and tax advisor before entering into any of thesestrategies. The following examples also assume that alloptions are American-style and, therefore, can beexercised at any time before expiration. In all of the fol-lowing examples, the premiums used are felt to be rea-sonable but, in reality, will not necessarily exist at orprior to expiration for a similar option.

Buying Calls

A call option contract gives its holder the right tobuy a specified number of shares of the underlyingstock at the given strike price on or before the expi-ration date of the contract.

I. Buying calls to participate in upward price movements

Buying an XYZ July 50 call option gives you theright to purchase 100 shares of XYZ common stockat a cost of $50 per share at any time before theoption expires in July. The right to buy stock at a fixedprice becomes more valuable as the price of the underly-ing stock increases.

Assume that the price of the underlying shareswas $50 at the time you bought your option and thepremium you paid was 31⁄2 (or $350). If the price ofXYZ stock climbs to $55 before your option expiresand the premium rises to 51⁄2, you have two choicesin disposing of your in-the-money option:

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Buy XYZ 50 Call at 31⁄2 –$350

Underlying Stock Risesto 55 & Premium Risesto 51⁄2

1) Exercise &buy stock –$5000Sell stock +$5500Cost of option –$350

Profit +$150OR2) Sell option +$550

Cost of option –$350

Profit +$200

Underlying Stock Fallsto 45 & Premium Fallsto 7⁄8

Sell option +$87.50Cost of option –$350.00

Loss –$262.50

plus the premium you receive from closing out yourposition by selling the option, if you choose to do so.

III. Buying calls to lock in a stock purchase price

An investor who sees an attractive stock price but doesnot have sufficient cash flow to buy at the present timecan use call options to lock in the purchase price for as faras eight months into the future.

Assume that XYZ is currently trading at $55per share and that you would like to purchase 100shares of XYZ at this price; however, you do not havethe funds available at this time. You know that youwill have the necessary funds in six months but youfear that the stock price will increase during this peri-od of time. One solution is to purchase a six-monthXYZ 55 call option, thereby establishing the maxi-mum price ($55 per share) you will have to pay for thestock. Assume the premium on this option is 41⁄4.

If in six months the stock price has risen to$70 and you have sufficient funds available, the callcan be exercised and you will own 100 shares ofXYZ at the option’s strike price of $55. For a costof $425 in option premium, you are able to buy your

This strategy allows you to benefit from an upward pricemovement (by either selling the option at a profit or buy-ing the stock at a discount relative to its current marketvalue) while limiting losses to the premium paid if theprice declines or remains constant.

II. Buying calls as part of an investment plan

A popular use of options known as “the 90/10 strate-gy” involves placing 10% of your investment funds inlong (purchased) calls and the other 90% in a moneymarket instrument (in our examples we use T-bills)held until the option’s expiration. This strategy providesboth leverage (from the options) and limited risk (from theT-bills), allowing the investor to benefit from a favorablestock price move while limiting the downside risk to the callpremium minus any interest earned on the T-bills.

Assume XYZ is trading at $60 per share. Topurchase 100 shares of XYZ would require aninvestment of $6,000, all of which would be exposedto the risk of a price decline. To employ the 90/10strategy, you would buy a six-month XYZ 60 call.Assuming a premium of 6, the cost of the optionwould be $600. This purchase leaves you with$5,400 to invest in T-bills for six months. Assumingan interest rate of 10% and that the T-bill is helduntil maturity, the $5,400 would earn interest of$270 over the six month period. The interest earnedwould effectively reduce the cost of the option to$330 ($600 premium minus $270 interest).

If the price of XYZ rises by more than $3.30per share, your long call will realize the dollarappreciation at expiration of a long position in 100shares of XYZ stock but with less capital invested inthe option than would have been invested in the100 shares of stock. As a result, you will realize ahigher return on your capital with the option thanwith the stock.

If the stock price instead increases by less than$3.30 or falls, your loss will be limited to the price youpaid for the option ($600) and this loss will be at leastpartially offset by the earned interest on your T-bill

20 21

Buy XYZ 60 Call at 6 –$600Buy T-Bill at 10% –$5400

Underlying Stock Risesto 65 & Premium Risesto 8

1) Sell option +$800T-bill interest(6 mo.) +$270Cost of option –$600

Profit +$470OR2) Exercise &

buy stock –$6000T-bill interest(6 mo.) +$270Sell stock +$6500Cost of option –$600

Profit +$170

Underlying Stock Fallsto 55 & Premium Fallsto 2

Sell option +$200T-bill interest(6 mo.) +$270Cost of option –$600

Loss –$130

The maximum potential loss in this strategy is limited tothe cost of the call plus the difference, if any, between thecall strike price and the short stock price. In this case, themaximum loss is equal to the cost of the call or $350.Profits will result if the decline in the stock price exceedsthe cost of the call.

Buying Puts

One put option contract gives its holder the right tosell 100 shares of the underlying stock at the givenstrike price on or before the expiration date of thecontract.

I. Buying puts to participate in downward pricemovements

Put options may provide a more attractive method thanshorting stock for profiting on stock price declines, inthat, with purchased puts, you have a known and pre-determined risk. The most you can lose is the cost of theoption. If you short stock, the potential loss, in theevent of a price upturn, is unlimited.

Another advantage of buying puts resultsfrom your paying the full purchase price in cash at

stock at $5,500 rather than $7,000. Your total costis thus $5,925 ($5,500 plus $425 premium), a sav-ings of $1,075 ($7,000 minus $5,925) when com-pared to what you would have paid to buy the stockwithout your call option.

If in six months the stock price has insteaddeclined to $50, you may not want to exercise yourcall to buy at $55 because you can buy XYZ stockon the stock market at $50. Your out-of-the-moneycall will either expire worthless or can be sold forwhatever time value it has remaining to recoup aportion of its cost. Your maximum loss with this strat-egy is the cost of the call option you bought or $425.

IV. Buying calls to hedge short stock sales

An investor who has sold stock short in anticipationof a price decline can limit a possible loss by purchas-ing call options. Remember that shorting stockrequires a margin account and margin calls may forceyou to liquidate your position prematurely. Althougha call option may be used to offset a short stockposition’s upside risk, it does not protect the optionholder against additional margin calls or prematureliquidation of the short stock position.

Assume you sold short 100 shares of XYZ stockat $40 per share. If you buy an XYZ 40 call at a premi-um of 31⁄2, you establish a maximum share price of $40that you will have to pay if the stock price rises and youare forced to cover the short stock position. Forinstance, if the stock price increases to $50 per share,you can exercise your option to buy XYZ at $40 pershare and cover your short stock position at a net costof $350 ($4,000 proceeds from short stock sale less$4,000 to exercise the option and $350 cost of theoption) assuming you can affect settlement of yourexercise in time. This is significantly less than the$1,000 ($4,000 proceeds from short stock sale less$5,000 to cover short) that you would have lost hadyou not hedged your short stock position.

22 23

Sell Stock Shortat $40 +$4000

Cover stock at 50 –$5000Proceeds fromshort sale +$4000

Loss –$1000

Cover stock at 30 –$3000Proceeds fromshort sale +$4000

Profit +$1000

Sell Stock Shortat $40 +$4000AND Buy 40 Callat 31⁄2 –$350

Exercise call tocover stock at 40 –$4000Cost of call –$350Proceeds fromshort sale +$4000

Loss –$350

Let call expire:cost of call –$350Cover stock at 30 –$3000Proceeds fromshort sale +$4000

Profit +$650

If Stock Price Increases from $40 to $50:

If Stock Price Decreases from $40 to $30:

shorted XYZ stock instead of purchasing the putoption, $250 versus $500 in this case.

This strategy allows you to benefit from downwardprice movements while limiting losses to the premiumpaid if prices increase.

II. Buying puts to protect a long stock position

You can limit the risk of stock ownership by simultane-ously buying a put on that stock, a hedging strategycommonly referred to as a “married put.” This strategyestablishes a minimum selling price for the stockduring the life of the put and limits your loss to thecost of the put plus the difference, if any, betweenthe purchase price of the stock and the strike priceof the put, no matter how far the stock pricedeclines. This strategy will yield a profit if the stockappreciation is greater than the cost of the putoption.

Assume you buy 100 shares of XYZ stock at$40 per share and, at the same time, buy an XYZJuly 40 put at a premium of 2. By purchasing thisput option for the $200 in premium, you haveensured that no matter what happens to the price ofthe stock, you will be able to sell 100 shares for $40per share, or $4,000.

If the price of XYZ stock increases to $50 pershare and the premium of your option drops to 7⁄8,your stock position is now worth $5,000 but your put

the time the put is bought. Shorting stock requires amargin account, and margin calls on a short salemight force you to cover your position prematurely,even though the position still may have profitpotential. As a put buyer, you can hold your posi-tion until the option’s expiration without incurringany additional risk.

Buying an XYZ July 50 put gives you the rightto sell 100 shares of XYZ stock at $50 per share at anytime before the option expires in July. This right tosell stock at a fixed price becomes more valuable as thestock price declines.

Assume that the price of the underlyingshares was $50 at the time you bought your optionand the premium you paid was 4 (or $400). If theprice of XYZ falls to $45 before July and the premi-um rises to 6, you have two choices in disposing ofyour in-the-money put option:

1) You can buy 100 shares of XYZ stock at $45 pershare and simultaneously exercise your putoption to sell XYZ at $50 per share, netting aprofit of $100 ($500 profit on the stock less the$400 option premium).

2) You can sell your put option contract, collectingthe difference between the premium paid andthe premium received, $200 in this case.

If, however, the holder has chosen not to act, hismaximum loss using this strategy would be the totalcost of the put option or $400. The profitability ofsimilar examples depends on how the time remain-ing until expiration affects the premium.Remember, time value declines sharply as an optionnears its expiration date.

If XYZ prices instead had climbed to $55prior to expiration and the premium fell to 11⁄2, yourput option would be out-of-the-money. You couldstill sell your option for $150, partially offsetting itsoriginal price. In most cases, the cost of this strategywill be less than what you would have lost had you

24 25

Buy XYZ 50 Put at 4 –$400

Underlying Stock Fallsto 45 & Premium Risesto 6

1) Purchasestock –$4500Exercise option +$5000Cost of option –$400

Profit +$100OR2) Sell option +$600

Cost of option –$400

Profit +$200

Underlying Stock Risesto 55 & Premium Fallsto 11⁄2

Sell option +$150Cost of option –$400

Loss –$250

III. Buying puts to protect unrealized profit inlong stock

If you have an established profitable long stock position,you can buy puts to protect this position against short-term stock price declines. If the price of the stockdeclines by more than the cost of the put, the putcan be sold or exercised to offset this decline. If youdecide to exercise, you may sell your stock at the putoption’s strike price, no matter how far the stockprice has declined.

Assume you bought XYZ stock at $60 pershare and the stock price is currently $75 per share.By buying an XYZ put option with a strike price of$70 for a premium of 11⁄2, you are assured of beingable to sell your stock at $70 per share during thelife of the option. Your profit, of course, would bereduced by the $150 you paid for the put. The $150in premium represents the maximum loss from thisstrategy.

For example, if the stock price were to drop to$65 and the premium increased to 6, you couldexercise your put and sell your XYZ stock for $70per share. Your $1,000 profit on your stock positionor $150 would be offset by the cost of your putoption resulting in a profit of $850 ($1,000 – $150).Alternatively, if you wished to maintain your posi-tion in XYZ stock, you could sell your in-the-money put for $600 and collect the differencebetween the premiums received and paid, $450($600 – $150) in this case, which might offset someor all of the lost stock value.

If the stock price were to climb, there would beno limit to the potential profit from the stock’sincrease in price. This gain on the stock, however,would be reduced by the cost of the put or $150.

is out-of-the-money. Your profit, if you sell yourstock, is $800 ($1,000 profit on the stock less theamount you paid for the put option, $200). However,if the price increase occurs before expiration, you mayreduce the loss on the put by selling it for whatevertime value remains, $87.50 in this case if the July 40put can be sold for 7⁄8.

If the price of XYZ stock instead had fallen to$30 per share, your stock position would only beworth $3,000 (an unrealized loss of $1,000) but youcould exercise your put, selling your stock for $40per share to break even on your stock position at acost of $200 (the premium you paid for your put).

This strategy is significant as a method for hedging along stock position. While you are limiting your down-side risk to the $200 in premium, you have not put aceiling on your upside profit potential.

26 27

Buy XYZ 40 Put at 2 –$200Buy 100 Shares at 40 –$4000

Underlying Stock Fallsto 30 & Premium Risesto 11

1) Exercise optionto sell stock +$4000Cost of stock& option –$4200

Loss –$200

Underlying Stock Risesto 50 & Premium Fallsto 7⁄8

Sell stock +$5000.00Sell option +$87.50

Cost of stock& option –$4200.00

Profit +$887.50

Buy XYZ 40 Put at 2 –$200Buy 100 Shares at 40 –$4000

Underlying Stock Fallsto 30 & Premium Risesto 11

2) Retain stockposition *Sell option +$1100Cost of option –$200

Profit on option +$900

*stock has unrealized loss of $1000

As a covered call writer, you own the underly-ing stock but are willing to forgo price increases inexcess of the option strike price in return for thepremium. You should be prepared to deliver thenecessary shares of the underlying stock (ifassigned) at any time during the life of the option.Of course, you may cancel your obligation at anytime prior to being assigned an exercise notice byexecuting a closing transaction, that is, buying a callin the same series.

A covered call writer’s potential profits andlosses are influenced by the strike price of the call hechooses to sell. In all cases, the writer’s maximumnet gain (i.e., including the gain or loss on the longstock from the date the option was written) will berealized if the stock price is at or above the strikeprice of the option at expiration or at assignment.Assuming the stock purchase price is equal to thestock’s current price: 1) If he writes an at-the-money call (strike price equal to the current price ofthe long stock), his maximum net gain is the premi-um he receives for selling the option; 2) If he writesan in-the-money call (strike price less than the cur-rent price of the long stock), his maximum net gainis the premium minus the difference between thestock purchase price and the strike price; 3) If hewrites an out-of-the-money call (strike price greaterthan the current price of the stock), his maximumnet gain is the premium plus the difference betweenthe strike price and the stock purchase price shouldthe stock price increase above the strike price.

If the writer is assigned, his profit or loss isdetermined by the amount of the premium plus thedifference, if any, between the strike price and theoriginal stock price. If the stock price rises above thestrike price of the option and the writer has his stockcalled away from him (i.e., is assigned), he forgoesthe opportunity to profit from further increases inthe stock price. If, however, the stock price decreas-es, his potential for loss on the stock position may besubstantial; the hedging benefit is limited only to theamount of the premium income received.

Selling Calls

As a call writer, you obligate yourself to sell, at thestrike price, the underlying shares of stock uponbeing assigned an exercise notice. For assuming thisobligation, you are paid a premium at the time yousell the call.

I. Covered Call Writing

The most common strategy is selling or writing callsagainst a long position in the underlying stock,referred to as covered call writing. Investors writecovered calls primarily for the following two reasons:

1) to realize additional return on their underlying stockby earning premium income; and

2) to gain some protection (limited to the amount of thepremium) from a decline in the stock price.

Covered call writing is considered to be a more con-servative strategy than outright stock ownershipbecause the investor’s downside risk is slightly offsetby the premium he receives for selling the call.

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Buy XYZ 70 Put at 11⁄2 –$150Own 100 Shares Bought at 60Which are Trading at 75at the Time You Buy Your Put –$6000

Underlying Stock Fallsto 65 & Premium Rises to 6

1) Exercise optionto sell stock +$7000Cost of stock –$6000Cost of option –$150

Profit +$850OR2) Retain stock position *

Sell option +$600Cost of option –$150

Profit on option +$450

*stock has unrealizedgain of $500

Underlying Stock Rises to 90 & Premium Falls to 1⁄8

1) Sell stock +$9000.00Sell option +$12.50Cost of stock –$6000.00Cost of option –$150.00

Profit +$2862.50OR2) Retain stock position *

Sell option +$12.50Cost of option –$150.00

Loss on option –$137.50

*stock has unrealizedgain of $3000

Of course, you are not limited to writing an optionwith a strike price equal to the price at which youbought the stock. You might choose a strike pricethat is below the current market price of your stock(i.e., an in-the-money option). Since the optionbuyer is already getting part of the desired benefit,appreciation above the strike price, he will be will-ing to pay a larger premium, which will provide youwith a greater measure of downside protection.However, you will also have assumed a greaterchance that the call will be exercised.

On the other hand, you could opt for writing a calloption with a strike price that is above the currentmarket price of your stock (i.e., an out-of-the-money option). Since this lowers the buyer’schances of benefiting from the investment, yourpremium will be lower, as will the chances that yourstock will be called away from you.

Assume you write an XYZ July 50 call at apremium of 4 covered by 100 shares of XYZ stockwhich you bought at $50 per share. The premiumyou receive helps to fulfill one of your objectives as acall writer: additional income from your investments.In this example, a $4 per share premium representsan 8% yield on your $50 per share stock investment.This covered call (long stock/short call) position willbegin to show a loss if the stock price declines by anamount greater than the call premium received or $4per share.

If the stock price subsequently declines to$40, your long stock position will decrease in valueby $1,000. This unrealized loss will be partially off-set by the $400 in premium you received for writingthe call. In other words, if you actually sell the stockat $40, your loss will be only $600.

On the other hand, if the stock price rises to$60 and you are assigned, you must sell your 100shares of stock at $50, netting $5,000. By writing acall option, you have forgone the opportunity to prof-it from an increase in value of your stock position inexcess of the strike price of your option. The $400 inpremium you keep, however, results in a net sellingprice of $5,400. The $6 per share difference betweenthis net selling price ($54) and the current marketvalue ($60) of the stock represents the “opportunitycost” of writing this call option.

30 31

Write XYZ 50 Call at 4 +$400Own 100 Shares Bought at 50 –$5000

Underlying Stock Fallsto 40 & Premium Fallsto 0

Retain stock *Call expires 0Option premiumincome +$400

Profit on option +$400

*stock has unrealized lossof $1000

Underlying Stock Risesto 60 & Premium Risesto 10

Stock called awayat 50 +$5000Cost of stock –$5000Option premiumincome +$400

Profit on option +$400

Write XYZ 45 Call at 6 +$600Own 100 Shares Bought at 50 –$5000

Underlying Stock Fallsto 40 & Premium Fallsto 0

Retain stock *Call expires 0Option premiumincome +$600

Profit on option +$600

*stock has unrealized lossof $1000

Underlying Stock Risesto 60 & Premium Risesto 15

Stock called awayat 45 +$4500Cost of stock –$5000Option premiumincome +$600

Profit +$100

Write XYZ 55 Call at 7⁄8 +$87.50Own 100 Shares Bought at 50 –$5000.00

Underlying Stock Fallsto 40 & Premium Fallsto 0

Retain stock *Call expires 0Option premiumincome +$87.50

Profit on option +$87.50

*stock has unrealized lossof $1000

Underlying Stock Risesto 60 & Premium Risesto 5

Stock called awayat 55 +$5500.00Cost of stock –$5000.00Option premiumincome +$87.50

Profit +$587.50

the price decline has no effect on your $600 profit.On the other hand, if the stock price subsequentlyclimbs to $75 per share, you likely will be assignedand will have to cover your position at a net loss of$400 ($1,000 loss on covering the call assignmentoffset by $600 in premium income). The call writer’slosses will continue to increase with subsequentincreases in the stock price.

As with any option transaction, an uncoveredcall writer may cancel his obligation at any timeprior to being assigned by executing a closing pur-chase transaction. An uncovered call writer also canmitigate his risk at any time during the life of theoption by purchasing the underlying shares of stock,thereby becoming a covered writer.

Selling Puts

Selling a put obligates you to buy the underlyingshares of stock at the option’s strike price uponassignment of an exercise notice. You are paid apremium when the put is written to partially com-pensate you for assuming this risk. As a put writer,you must be prepared to buy the underlying stock atany time during the life of the option.

I. Covered Put Writing

A put writer is considered to be covered if he has acorresponding short stock position. For purposes ofcash account transactions, a put writer is also con-sidered to be covered if he deposits cash or cashequivalents equal to the exercise value of the optionwith his broker. A covered put writer’s profit poten-tial is limited to the premium received plus the dif-ference between the strike price of the put and theoriginal share price of the short position. Thepotential loss on this position, however, is substan-tial if the price of the stock increases significantlyabove the original share price of the short position.In this case, the short stock will accrue losses whilethe offsetting profit on the put sale is limited to thepremium received.

In short, the writer of a covered call option, in returnfor the premium he receives, forgoes the opportunityto benefit from an increase in the stock price whichexceeds the strike price of his option, but continuesto bear the risk of a sharp decline in the value of hisstock which will only be slightly offset by the premi-um he received for selling the option.

II.Uncovered Call Writing

A call option writer is uncovered if he does not ownthe shares of the underlying security represented bythe option. As an uncovered call writer, your objectiveis to realize income from the writing transaction with-out committing capital to the ownership of the underly-ing shares of stock. An uncovered option is alsoreferred to as a naked option. An uncovered callwriter must deposit and maintain sufficient marginwith his broker to assure that the stock can be pur-chased for delivery if and when he is assigned.

The potential loss of uncovered call writing isunlimited. However, writing uncovered calls can beprofitable during periods of declining or generally sta-ble stock prices, but investors considering this strategyshould recognize the significant risks involved:

1) If the market price of the stock rises sharply, thecalls could be exercised. To satisfy your deliveryobligation, you may have to buy stock in themarket for more than the option’s strike price.This could result in a substantial loss.

2) The risk of writing uncovered calls is similar tothat of selling stock short, although, as an optionwriter, your risk is cushioned somewhat by theamount of premium received.

As an example, if you write an XYZ July 65 call for apremium of 6, you will receive $600 in premiumincome. If the stock price remains at or below $65,you may not be assigned on your option and, if youare not assigned because you have no stock position,

32 33

ConclusionThe intended purpose of this booklet is to providean introduction to the fundamentals of buying andwriting stock options, and to illustrate some of thebasic strategies available.

You have been shown that exchange-tradedoptions have many benefits including flexibility,leverage, limited risk for buyers employing thesestrategies, and contract performance under the sys-tem created by OCC’s Rules. Options allow you toparticipate in price movements without committingthe large amount of funds needed to buy stock out-right. Options can also be used to hedge a stock posi-tion, to acquire or sell stock at a purchase price morefavorable than the current market price, or, in thecase of writing options, to earn premium income.

Whether you are a conservative or growth-oriented investor, or even a short-term, aggressivetrader, your broker can help you select an appropri-ate options strategy. The strategies presented in thisbooklet do not cover all, or even a significant num-ber, of the possible strategies utilizing options.These are the most basic strategies, however, andwill serve well as building blocks for the more com-plex strategies available.

Despite their many benefits, options involve riskand are not suitable for everyone. An investor whodesires to utilize options should have well-definedinvestment objectives suited to his particular financialsituation and a plan for achieving these objectives. Thesuccessful use of options require a willingness to learnwhat they are, how they work, and what risks are asso-ciated with particular options strategies.

Armed with an understanding of the funda-mentals, and with additional information and assis-tance that is readily available from many brokeragefirms and other sources, individuals seeking expand-ed investment opportunities in today’s markets willfind options trading challenging, often fast moving,and potentially rewarding.

II. Uncovered Put Writing

A put writer is considered to be uncovered if hedoes not have a corresponding short stock positionor has not deposited cash equal to the exercise valueof the put. Like uncovered call writing, uncoveredput writing has limited rewards (the premiumreceived) and potentially substantial risk (if pricesfall and you are assigned). The primary motivationsfor most put writers are:

1) to receive premium income; and

2) to acquire stock at a net cost below the current mar-ket value.

If the stock price declines below the strike price ofthe put and the put is exercised, you will be obli-gated to buy the stock at the strike price. Your costwill, of course, be offset at least partially by the pre-mium you received for writing the option. You willbegin to suffer a loss if the stock price declines by anamount greater than the put premium received. Aswith writing uncovered calls, the risks of writinguncovered put options are substantial. If instead thestock price rises, your put will most likely expire.

Assume you write an XYZ July 55 put for apremium of 5 and the market price of XYZ stocksubsequently drops from $55 to $45 per share. If youare assigned, you must buy 100 shares of XYZ for acost of $5,000 ($5,500 to purchase the stock at thestrike price minus $500 premium income received).

If the price of XYZ had dropped by less thanthe premium amount, say to $52 per share, youmight still have been assigned but your cost of$5,000 would have been less than the current mar-ket value of $5,200. In this case, you could havethen sold your newly acquired (as a result of yourput being assigned) 100 shares of XYZ on the stockmarket with a profit of $200.

Had the market price of XYZ remained at orabove $55, it is highly unlikely that you would beassigned and the $500 premium would be your profit.

34 35

Covered put option writing: A strategy in whichone sells put options and simultaneously is short anequivalent position in the underlying security.

Derivative security: A financial security whosevalue is determined in part from the value and char-acteristics of another security, the underlying security.

Equity options: Options on shares of an individ-ual common stock.

European-style option: An option contract thatmay be exercised only during a specified period oftime just prior to its expiration.

Exercise: To implement the right under which theholder of an option is entitled to buy (in the case ofa call) or sell (in the case of a put) the underlyingsecurity.

Exercise price: See Strike price.

Exercise settlement amount: The differencebetween the exercise price of the option and theexercise settlement value of the index on the day anexercise notice is tendered, multiplied by the indexmultiplier.

Expiration cycle: An expiration cycle relates tothe dates on which options on a particular underly-ing security expire. A given option, other thanLEAPS®, will be assigned to one of three cycles, theJanuary cycle, the February cycle or the March cycle(See Appendix). At any point in time, an optionwill have contracts with four expiration datesoutstanding, the two near-term months and twofurther-term months.

Expiration date: The day in which an optioncontract becomes void. All holders of options mustindicate their desire to exercise, if they wish to doso, by this date.

Expiration time: The time of day by which all exer-cise notices must be received on the expiration date.

Hedge: A conservative strategy used to limitinvestment loss by effecting a transaction which off-sets an existing position.

Glossary

American-style option: An option contract thatmay be exercised at any time between the date ofpurchase and the expiration date. Most exchange-traded options are American-style.

Assignment: The receipt of an exercise notice byan option writer (seller) that obligates him to sell (inthe case of a call) or purchase (in the case of a put)the underlying security at the specified strike price.

At-the-money: An option is at-the-money if thestrike price of the option is equal to the marketprice of the underlying security.

Call: An option contract that gives the holder theright to buy the underlying security at a specifiedprice for a certain, fixed period of time.

Capped-style option: A capped option is an optionwith an established profit cap or cap price. The capprice is equal to the option’s strike price plus a capinterval for a call option or the strike price minus a capinterval for a put option. A capped option is automati-cally exercised when the underlying security closes ator above (for a call) or at or below (for a put) theoption’s cap price.

Class of options: Option contracts of the sametype (call or put) and style (American, European orCapped) that cover the same underlying security.

Closing purchase: A transaction in which thepurchaser’s intention is to reduce or eliminate ashort position in a given series of options.

Closing sale: A transaction in which the seller’sintention is to reduce or eliminate a long position ina given series of options.

Covered call option writing: A strategy in whichone sells call options while simultaneously owning anequivalent position in the underlying security.

36 37

Premium: The price of an option contract, deter-mined in the competitive marketplace, which thebuyer of the option pays to the option writer for therights conveyed by the option contract.

Put: An option contract that gives the holder theright to sell the underlying security at a specifiedprice for a certain fixed period of time.

Secondary Market: A market that provides forthe purchase or sale of previously sold or boughtoptions through closing transactions.

Series: All option contracts of the same class thatalso have the same unit of trade, expiration date andstrike price.

Short position: A position wherein a person’sinterest in a particular series of options is as a netwriter (i.e., the number of contracts sold exceeds thenumber of contracts bought).

Strike price: The stated price per share for whichthe underlying security may be purchased (in thecase of a call) or sold (in the case of a put) by theoption holder upon exercise of the option contract.

Time value: The portion of the option premiumthat is attributable to the amount of time remaininguntil the expiration of the option contract. Timevalue is whatever value the option has in addition toits intrinsic value.

Type: The classification of an option contract aseither a put or a call.

Uncovered call option writing: A short calloption position in which the writer does not own anequivalent position in the underlying security repre-sented by his option contracts.

Uncovered put option writing: A short putoption position in which the writer does not have acorresponding short position in the underlyingsecurity or has not deposited, in a cash account,cash or cash equivalents equal to the exercise valueof the put.

Holder: The purchaser of an option.

In-the-money: A call option is in-the-money ifthe strike price is less than the market price of theunderlying security. A put option is in-the-money ifthe strike price is greater than the market price ofthe underlying security.

Intrinsic value: The amount by which an optionis in-the-money (see above definition).

LEAPS®: Long-term Equity AnticiPationSecurities®, or LEAPS®, are long-term stock orindex options. LEAPS®, like all options, are avail-able in two types, calls and puts, with expirationdates up to three years in the future.

Long position: A position wherein an investor’sinterest in a particular series of options is as a netholder (i.e., the number of contracts bought exceedsthe number of contracts sold).

Margin requirement (for options): Theamount an uncovered (naked) option writer isrequired to deposit and maintain to cover a position.The margin requirement is calculated daily.

Naked writer: See Uncovered call writing andUncovered put writing.

Opening purchase: A transaction in which thepurchaser’s intention is to create or increase a longposition in a given series of options.

Opening sale: A transaction in which the seller’sintention is to create or increase a short position in agiven series of options.

Open interest: The number of outstandingoption contracts in the exchange market or in a par-ticular class or series.

Out-of-the-money: A call option is out-of-the-money if the strike price is greater than the marketprice of the underlying security. A put option isout-of-the-money if the strike price is less than themarket price of the underlying security.

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AppendixJanuary Sequential Cycle

Current Month Available Months*Jan Jan Feb Apr JulFeb Feb Mar Apr JulMar Mar Apr Jul OctApr Apr May Jul OctMay May Jun Jul OctJun Jun Jul Oct JanJul Jul Aug Oct JanAug Aug Sep Oct JanSep Sep Oct Jan AprOct Oct Nov Jan AprNov Nov Dec Jan AprDec Dec Jan Apr Jul

February Sequential Cycle

Current Month Available Months*Jan Jan Feb May AugFeb Feb Mar May AugMar Mar Apr May AugApr Apr May Aug NovMay May Jun Aug NovJun Jun Jul Aug NovJul Jul Aug Nov FebAug Aug Sep Nov FebSep Sep Oct Nov FebOct Oct Nov Feb MayNov Nov Dec Feb MayDec Dec Jan Feb May

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Underlying security: The security subject tobeing purchased or sold upon exercise of the optioncontract.

Volatility: A measure of the fluctuation in themarket price of the underlying security.Mathematically, volatility is the annualized standarddeviation of returns.

Writer: The seller of an option contract.

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For More InformationThe American Stock Exchange, L.L.C.

A Subsidiary of The Nasdaq-Amex Market GroupAn NASD Company86 Trinity PlaceNew York, NY 10006-1872 USA1-800-THE-AMEX(212) 206-1000www.nasdaq_amex.comE-mail: options@nasdaq_amex.com

Chicago Board Options Exchange, Inc.

LaSalle at Van BurenChicago, IL 60605 USA1-800-OPTIONS(312) 786-5600www.cboe.comE-mail: investor_services@cboe.com

The Options Clearing Corporation

440 South LaSalle Street, Suite 2400Chicago, IL 60605 USA1-800-537-4258(312) 322-6200www.optionsclearing.com

International Securities Exchange L.L.C.

60 Broad Street26th FloorNew York, NY 10004 USA(212) 943-2400www.iseoptions.comE-mail: Mail@iseoptions.com

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March Sequential Cycle

Current Month Available Months*Jan Jan Feb Mar JunFeb Feb Mar Jun SepMar Mar Apr Jun SepApr Apr May Jun SepMay May Jun Sep DecJun Jun Jul Sep DecJul Jul Aug Sep DecAug Aug Sep Dec MarSep Sep Oct Dec MarOct Oct Nov Dec MarNov Nov Dec Mar JunDec Dec Jan Mar Jun

* Available Months = the option expiration dates available fortrading prior to the third Friday of the Current Month. Thereare always 2 near-term and 2 far-term months available. Themost recently added expiration month is listed in bold-facedtype. This new expiration month is added on the Mondayfollowing the third Friday of the month prior to the CurrentMonth. For example, in the February Cycle, if the CurrentMonth is September, the most recently added expiration(October) would have been added following the Augustexpiration. These tables do not include LEAPS®. EquityLEAPS®/long-term stock options expire in January of thespecific year.

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Pacific Exchange, Inc.

Options Marketing301 Pine StreetSan Francisco, CA 94104 USA1-800-825-5773(415) 393-4028www.pacificex.comE-mail: info@pacificex.com

Philadelphia Stock Exchange, Inc.

1900 Market StreetPhiladelphia, PA 19103 USA1-800-THE-PHLX(215) 496-5404www.phlx.comE-mail: info@phlx.com

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Notes

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