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Options

Options Explained

An option is a contract that gives the buyer the right,

but generally not the obligation, to buy or sell an

underlying asset at a specific price on or before a

certain date. An option, just like a stock or bond, is a

security.

2 Options | Scotia iTRADE

What are Options?

Options Explained

An option is a contract that gives the buyer the

right, but generally not the obligation, to buy or

sell an underlying asset at a specific price on or

before a certain date. An option, just like a

stock or bond, is a security. It is also a binding

contract with strictly defined terms and

properties.

The two types of options are calls and puts:

A call

A call gives the holder the right to buy a

specific amount of a certain asset at a

certain price within a specific period of

time. Calls are similar to having a long

position on a stock. Buyers of calls hope

that the stock will increase substantially

before the option expires.

A put

A put gives the holder the right to sell a

specific amount of a certain asset at a

certain price within a specific period of

time. Puts are very similar to having a short

position on a stock. Buyers of puts hope

that the price of the stock will fall before

the option expires.

Why Use Options?

Investors and Traders use options to:

Protect stock holdings from a decline in

market price

Earn income from current stock holdings

Prepare to buy stock at a lower price

Position for a big market move even when

they aren’t sure which way prices will

move

Benefit from a stock price's rise or fall

without incurring the cost of buying or

selling the stock outright

Other benefits include

Efficient, Liquid Markets

Flexibility

Leverage

Limited Risk

Guaranteed Contract Performance

Options

Options are used, amongst others, to protect stock

holdings from a decline in market price, earn income

from current stock holdings and to buy stock at a

lower price.

3 Options | Scotia iTRADE

Standardized option contracts provide orderly, efficient, and liquid option markets. Except under special

circumstances, stock option contracts generally cover 100 shares of the underlying stock. The strike

price of an option is the specified share price at which the shares of stock will be bought or sold if the

buyer of an option (the holder) exercises his/her option.

As a result of this standardization, option prices (premiums) can be obtained quickly and easily at any

time during trading hours. Additionally, closing option prices for exchange-traded options are published

daily in many newspapers. Option prices are set by buyers and sellers on the exchange floor, where all

trading is conducted in the open, competitive manner of an auction market.

Flexibility

Options are an extremely versatile investment tool. Because of their unique risk/reward structure,

options can be used in many combinations with other option contracts and/or other financial

instruments to create either a hedged or speculative position.

Leverage

A stock option allows you to set the price, for a specific period of time, at which you can purchase

or sell 100 shares of stock. To buy the right to control the stock in that way, you pay a price (the

premium) which is only a percentage of what you would have to pay to own the stock outright.

That leverage means that by using options you may be able to increase your potential benefit from

a stock's price movements.

Option Buyer pays a premium and secures a right

Seller collects a premium and has an obligation

Seller’s Right

Call To buy shares at a specified price over a specific time period

To deliver shares at a specific price over a specific time period

Keeps the premium from selling the option

Put To sell shares at a specific price over a specific time period

To buy shares at a specific price over a specific time period

Keeps the premium from selling the option

4 Options | Scotia iTRADE

Options Pricing

Understanding Options Pricing

The specific stock on which an option contract is

based is commonly referred to as the

underlying security. Options are categorized

as derivative securities because their value is

derived in part from the value and

characteristics of the underlying security. A

stock option contract's unit of trade is the

number of shares of underlying stock which are

represented by that option. Generally speaking,

stock options have a unit of trade of 100 shares.

This means that one option contract represents

the right to buy or sell 100 shares of the

underlying security.

Strike Price

The strike price, or exercise price, of an

option is the specified share price at which

the shares of stock can be bought or sold by

the holder, or buyer, of the option contract

if they exercise their right against a writer, or

seller, of the option. To exercise your option

is to exercise your right to buy (in the case of

a call) or sell (in the case of a put) the

underlying shares at the specified strike

price of the option.

The strike price, a fixed specification of an

option contract, should not be confused

with the premium, the price at which the

contract trades on the market, which

fluctuates, based on market conditions.

In-the-Money

If the strike price of a call option is less than the

current market price of the underlying security,

the call is said to be in-the-money because the

holder of this call has the right to buy the stock

at a price which is less than the price that would

have to be paid to buy the stock in the stock

market.

Out-of-the-Money

If a put option has a strike price that is greater

than the current market price of the underlying

security, it is also said to be in-the-money

because the holder of this put has the right to

sell the stock at a price which is greater than

the price that would be received for selling the

stock in the stock market.

Out-of-the-Money and At-the-

Money

The converse of in-the-money is, not

surprisingly, out-of-the-money. If the strike

price equals the current market price, the

option is said to be at the-money.

Premium

Option buyers pay a price for the right to buy or

sell the underlying security. This price is called

the option premium. The premium is paid to

the writer, or seller, of the option. In return, the

writer of a call option is obligated to deliver the

underlying security (in return for the strike price

per share) to an option buyer if the call is

exercised and, likewise, the writer of a put

option is obligated to take delivery of the

underlying security (at a cost of the strike price

per share) from an option buyer if the put is

exercised. Whether or not an option is ever

5 Options | Scotia iTRADE

exercised, the writer keeps the premium.

Premiums are quoted on a per share basis.

Thus, a premium of $1.00 represents a

premium payment of $100.00 per option

contract ($1.00 x 100 shares).

Underlying Stock Price

The value of an option depends heavily upon

the price of its underlying stock. If the price of

the stock is above a call option's strike price, the

call option is said to be in-the-money. Likewise,

if the stock price is below a put option's strike

price, the put option is in-the-money. The

difference between an in-the-money option's

strike price and the current market price of a

share of its underlying security is referred to as

the option's intrinsic value.

Only in-the-money options have intrinsic value.

For example, if a call option's strike price is $45

and the underlying shares are trading at $60,

the option has intrinsic value of $ 15 because

the holder of that option could exercise the

option and buy the shares at $45. The buyer

could then immediately sell these shares on the

stock market for $60, yielding a profit of $ 15

per share, or $ 1,500 per option contract

When the underlying share price is equal to the

strike price, the option (either call or put) is at-

the-money. An option which is not in-the-

money or at-the-money is said to be out-of-the-

money. An at-the-money or out-of-the-money

option has no intrinsic value, but this does not

mean it can be obtained at no cost.

Time Value

The primary components of time value are time

remaining until expiration, volatility, dividends,

and interest rates. Time value is the amount by

which the option premium exceeds the intrinsic

value.

Option Premium = Intrinsic

Value + Time Value

For in-the-money options, the time value is the

excess portion over intrinsic value. For at-the-

money and out-of-the-money options, the time

value is the option premium.

Time Remaining Until Expiration

Generally, the longer the time remaining until

an option's expiration date, the higher the

option premium because there is a greater

possibility that the underlying share price might

move so as to make the option in-the-money.

Time value drops rapidly in the last several

weeks of an option's life.

Volatility

Volatility is the propensity of the underlying

security's market price to fluctuate either up or

down. Therefore, volatility of the underlying

share price influences the option premium. The

higher the volatility of the stock, the higher the

premium because there is, again, a greater

possibility that the option will move in-the-

money.

6 Options | Scotia iTRADE

Dividends

Regular cash dividends are paid to the stock

owner. Therefore, cash dividends affect option

premiums through their effect on the

underlying share price. Because the stock price

is expected to fall by the amount of the cash

dividend, higher cash dividends tend to imply

lower call premiums and higher put premiums.

Options customarily reflect the influences of

stock dividends (e.g., additional shares of stock)

and stock splits because the number of shares

represented by each option is adjusted to take

these changes into consideration.

Interest Rates

Historically, higher interest rates have tended to

result in higher call premiums and lower put

premiums.

Read an Options Quote

Options are widely quoted in the financial

press. Although there may be differences in

how the statistics are presented, invariably

the option tables always focus on the same

core information. To help us define terms,

imagine the month is September and we're

checking out option activity in our favorite

newspaper.

Here is how one option quote might look for

a fictional call on shares of a company

known as ABC Inc.

ABC 10/18/14 20 Call

ABC

Underlying Security. The name of the

particular security (or index such as OEX or

TSX) that an investor has the right to buy

or sell according to the terms of a listed

option contract. This is known as the

‘underlying security’.

10/18/14

Expiry date October 18, 2014.

All options have fixed expiration dates.

Each class of options (all options of the

same type, either calls or puts, on the

same underlying security, are considered

the same class) has a set of four expiration

dates. Together, they are known as the

option's ‘cycle’. There are three cycles. One

cycle is January, April, July, and October;

another is February, May, August and

7 Options | Scotia iTRADE

November; and the third is March, June,

September and December.

Normally options expire on the Saturday

following the third Friday of their specified

month. In practice, however, this means

that the third Friday is the last day you

have to trade your option (some

exceptions do exist).

The holder of an option has the right to

buy or sell (depending on if the option is a

call or a put) the underlying stock any time

until the expiration date. In addition,

option writers can terminate their side of

the contract by buying to close at any time

before the option expires.

20

Exercise or ‘Strike’ Price. The price at which

the buyer may buy stock from the writer

(in the case of a call) or sell stock to the

writer (in the case of a put). In the example

above, if the buyer exercises the option, he

is guaranteed a price of $20 a share for

ABC regardless of how high the price of

ABC might rise before the expiration date.

Premium Price

The premium price is the market price of

an option contract at a given time. When

you purchase an option contract, you pay

the premium price immediately. The

premium quoted is for one option contract

but because that contract covers 100

shares (known as the multiplier, usually

100 shares for stocks), you must multiply

the premium dollar amount quoted by 100

to derive the actual cost of the contract.

Thus, a $3 premium actually means one

contract costs $300. Please note that

option premiums fluctuate.

Call

Class There are two types of options, calls

or puts, each is referred to as a class of

options. All of the calls listed for the same

underlying stock are one class and all of

the puts listed for that stock are the other

class.

Get an Options Chain

An Options chain is a form of quoting options

prices through a list of all the options for a given

security. It is a listing of all the call and all the

put option strike prices along with their

premiums for a given maturity period.

You can access the Option chain by navigating

to Quotes & Research, enter the stock you want

to purchase the options on, and select ‘Options

Chain’ from the fly-out menu.

8 Options | Scotia iTRADE

You can also enter the desired stock, click on ‘Go’ and then select ‘Options’ from the submenu.

You will then have access to the Options chain. From here, you can select the following information:

Chain (Calls and/or Puts)

Sort by Month or Strike Price

Strike Price

Expiry

Option Type

Click on ‘Get Chain’ to view your selection.

9 Options | Scotia iTRADE

[Type a quote from the document or the summary of an interesting point. You can position the text box

anywhere in the document. Use the Drawing Tools tab to change the formatting of the pull quote text

box.]

Call Options can be found on the left, Put Options on the right

Shaded areas indicate In-The-Money Options

Click on ‘Analyse’ to access Options Greeks

Use the Quick Menu drop down to trade Options

10 Options | Scotia iTRADE

Invest in Options

Options trading can form an important part of a successful investment portfolio. At Scotia iTRADE®, we give you the power to trade options easily and track the ups and downs of the market.

Select Account

Select Options

Select Symbol or use magnifying glass

to search

Select Market

Select Option Type, i.e. call or put

Enter Expiration and Strike

Select Order Type, i.e. buy to open, sell

to close, sell to open

(covered/uncovered), buy to close

(covered/uncovered)

Enter number of contracts

Enter Price Type and Term

Click ‘Preview Order’. Check your order

carefully before inserting your Access

Code and submitting your order

11 Options | Scotia iTRADE

To learn more about Options and Option Tools, join our Webinars or view our

Webinars on Demand.

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Investor Information Centre 48 Yonge Street (Yonge/Wellington) Toronto, ON, M5E 1G6 Tel: 1-888-769-3723 Email: education@scotiaitrade.com

Scotia iTRADE® (Order-Execution Only Accounts) is a division of Scotia Capital Inc. ("SCI"). SCI is a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund. Scotia iTRADE does not provide investment advice or recommendations and investors are responsible for their own investment decisions. ®Registered trademark of The Bank of Nova Scotia. Used under license.

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