Listed Options and Their Characteristics
Options are derivative contracts: their value is derived from an underlying security. Before you can understand strategies or calculate profit and loss, you need to know exactly what an options contract is, who has rights, who has obligations, and how contracts are structured.
Call and Put Definitions
Every options contract falls into one of two categories:
| Contract Type | Buyer (Holder) Right | Seller (Writer) Obligation |
|---|---|---|
| Call option | Right to buy 100 shares at the strike price before expiration | Obligation to sell 100 shares at the strike price if assigned |
| Put option | Right to sell 100 shares at the strike price before expiration | Obligation to buy 100 shares at the strike price if assigned |
- The buyer pays a premium to acquire the right; the seller collects the premium in exchange for accepting the obligation
- A call buyer is bullish: they expect the stock price to rise above the strike
- A put buyer is bearish: they expect the stock price to fall below the strike
- A call writer is bearish to neutral: they believe the stock will stay at or below the strike
- A put writer is bullish to neutral: they believe the stock will stay at or above the strike
Remember: Rights belong to the buyer. Obligations belong to the seller. The buyer always pays the premium; the seller always receives it.
Contract Specifications
Options are standardized by the exchanges. The exchange sets everything except one term:
| Specification | Standard Equity Option |
|---|---|
| Contract size | 100 shares of the underlying stock |
| Premium quotation | Quoted per share; multiply by 100 for total cost |
| Strike price intervals | $2.50 for strikes under $25; $5 for $25-$200; $10 for strikes above $200 |
| Expiration | Third Friday of the expiration month (standard monthly); weekly and quarterly series also available |
| Exercise style | American-style (exercisable any business day up to and including expiration) |
| Settlement | Physical delivery of the underlying stock; T+1 after exercise |
- The only term negotiated between buyer and seller is the premium: the market price of the contract
- Everything else is fixed by the exchange to make options fungible (interchangeable) so they can trade freely on the secondary market
Exam Tip: Gotchas
- Options premiums are quoted per share, not per contract. When a question says "the XYZ 50 call is trading at 4," the total cost is $400 (4 x 100 shares), not $4. This trap appears repeatedly in cost basis and profit/loss calculations.
- The only negotiated term is the premium. Everything else (contract size, strike intervals, expiration, exercise style) is standardized by the exchange.
Contract Adjustments: Stock Splits and Dividends
When a corporate action changes the underlying stock, options contracts must adjust so the aggregate contract value stays the same before and after:
Even Splits (2-for-1, 4-for-1)
- The number of contracts increases and the strike price decreases proportionally
- Each contract still covers 100 shares
- Example: 1 XYZ 80 call becomes 2 XYZ 40 calls after a 2-for-1 split
Odd Splits (3-for-2, 5-for-4)
- The number of contracts stays the same
- The strike price adjusts and the deliverable per contract changes (creating non-standard or "adjusted" contracts)
- Example: 1 XYZ 90 call covering 100 shares becomes 1 XYZ 60 call covering 150 shares after a 3-for-2 split
Exam Tip: Gotchas
- Even splits change the number of contracts; odd splits change the deliverable per contract. Both adjust the strike price, but only even splits keep the standard 100-share contract size.
Cash Dividends vs. Stock Dividends
| Corporate Action | Contract Adjustment? |
|---|---|
| Ordinary cash dividend | No - no change to strike or contract size |
| Stock dividend | Yes - treated like an odd split (strike adjusts, deliverable changes) |
| Stock split | Yes - even splits multiply contracts; odd splits adjust deliverables |
- When a stock goes ex-dividend for a cash dividend, the stock price drops by the dividend amount on the ex-date, which affects the premium, but the contract terms do not change
Exam Tip: Gotchas
- Ordinary cash dividends do NOT adjust options contracts. Only stock dividends and stock splits trigger adjustments. The exam often presents an ex-dividend scenario and asks whether the option contract changes. The answer is no.