Trading Options Greeks: How Time, Volatility, and Other Pricing Factors Drive Profits by Dan Passarelli
PART I
The Basics of
Option Greeks
CHAPTER 1
The Basics
To understand how options work, one needs first to understand what an
option is. An option is a contract that gives its owner the right to buy or the
right to sell a fixed quantity of an underlying security at a specific price within
a certain time constraint. There are two types of options: calls and puts. A call
gives the owner of the option the right to buy the underlying security.
A put gives the owner of the option the right to sell the underlying security. As
in any transaction, there are two parties to an option contract—a buyer and
a seller.
Contractual Rights and Obligations
The option buyer is the party who owns the right inherent in the contract. The
buyer is referred to as having a long position and may also be called the holder,
or owner, of the option. The right doesn’t last forever. At some point the
option will expire. At expiration, the owner may exercise the right or, if the
option has no value to the holder, let it expire without exercising it. But he
need not hold the option until expiration. Options are transferable—they can
be traded intraday in much the same way as stock is traded. Because it’s
uncertain what the underlying stock price of the option will be at expiration,
much of the time this right has value before it expires. The uncertainty of stock
prices, after all, is the raison d’eˆtre of the option market.
A long position in an option contract, however, is fundamentally
different from a long position in a stock. Owning corporate stock affords
the shareholder ownership rights, which may include the right to vote in
corporate affairs and the right to receive dividends. Owning an option
represents strictly the right either to buy the stock or to sell it, depending
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