Options

The whole unit on one sheet: rights and obligations, the math, and the risk traps the exam loves.

Core Concepts: The Four Positions

• Long = buyer = pays premium = rights. Short = seller = receives premium = obligations.
• Buyers want the option to have value (exercise). Sellers want it to expire worthless (keep premium).

Breakevens (calls add, puts subtract)

• Naked call/put: calls add the premium to strike, puts subtract; same formula long or short.
• Stock-plus-option flips it: premium received is subtracted (covered call), premium paid is added (protective put).

The One-Liners That Win Points

• Premium = intrinsic value + time value. Neither piece can be negative; minimum is $0.
• Only the holder can exercise; the writer can only be assigned. Assignment among writers is random.
• Naked call = unlimited risk (the most dangerous strategy). Naked put loss is defined: strike - premium.
• Covered call caps upside; protective put caps downside. Neither eliminates all risk.
• Covered call = income; protective put = insurance.
• Equity options = physical delivery, usually American; index options = cash settled, usually European.
• Exercise style and settlement type are separate concepts that happen to pair together.

Numbers to Lock In

• One standard equity contract = 100 shares; a $3 premium = $300 total. The multiplier hits every calculation.
• Standard equity options expire the third Friday of the expiration month.
• Index option multiplier is typically $100.
• Options agreement: customer has 15 days after approval to sign and return it.

Memory Aids (use these verbatim)

• Call UP, Put DOWN. Calls are in-the-money when the market goes UP above the strike; puts when the market goes DOWN below the strike.
• American = Any time. European = Expiration only.

Moneyness

• Call ITM: market above strike. Put ITM: market below strike. At-the-money = market equals strike.
• Only in-the-money options have intrinsic value; out-of-the-money options can still carry time value.
• Time value always decays toward expiration; at expiration only intrinsic value remains.

Account Opening (ODD)

• The options disclosure document (ODD), titled "Characteristics and Risks of Standardized Options," is prepared by the Options Clearing Corporation (OCC), not FINRA or the firm.
• ODD must be delivered at or before account approval; no exceptions, never after.
• A Registered Options Principal (ROP) must approve the account.
• Customer can trade after approval, even before the signed agreement is returned.

Top Gotchas

• Long put and short call are both bearish, but different: the put is a right (limited risk), the short call an obligation (unlimited risk).
• The OCC guarantees all listed options (becomes buyer to every seller, seller to every buyer) but is not a regulator.
• "American" and "European" refer to exercise timing, not geography; both trade on U.S. exchanges.
• European-style options can still be traded any time; only exercising is restricted.
• "Covered" differs by type: calls covered by owning stock, puts covered by cash set aside. Naked options always need a margin account; covered calls can sit in a cash account.
• Index options settle in cash because you cannot deliver "shares" of an index.

One-Breath Recap

Buyers hold rights and risk only premium; sellers take premium and carry the obligations, with naked calls the one truly unlimited danger. Calls add, puts subtract for breakeven; the OCC guarantees and the ODD comes first.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Options unit for the complete lesson.