Every options question comes down to a few moves: read the contract, value it, follow it through exercise, hedge with it and tax it. Each move has a rule number or a formula behind it.
An option gives its buyer a right, and its seller an obligation, to trade an asset at a fixed price until a fixed date. Each contract has two sides:
- Holder: The buyer, or long side, who decides whether to exercise.
- Writer: The seller, or short side, who must perform if assigned.
Cboe Exchange, Inc. (Cboe) Rule 1.1 defines the listed option terms you'll see in every question:
- Call: The holder may buy the underlying at the strike price, and the writer must sell if assigned.
- Put: The holder may sell the underlying at the strike price, and the writer must buy if assigned.
- Underlying: This is the stock, index, currency or interest rate the option covers.
- Strike price: This is the price per share, or per index unit, at which exercise takes place.
Common mistakes
- Reversing the put test: A 50 put with the stock at $45 is in the money by $5, not out of the money.
- Adding long calls to long puts: Long 30,000 calls and long 25,000 puts are on opposite sides, so neither side reaches a 50,000 limit. The 55,000 total is the trap answer.
- Calling an expired written premium long-term: A LEAPS call written 14 months before it expires still produces a short-term gain.
Bottom line
- A listed stock option covers 100 shares, expires the third Friday, and is issued and guaranteed by OCC.
- Premium equals intrinsic value plus time value; an out-of-the-money premium is all time value.
- Equity options are American-style and deliver stock one business day after exercise; SPX is European-style and settles in cash.
- Whole-share splits add contracts and cut the strike; ordinary cash dividends bring no adjustment.
Exam shortcut
Break every strategy question into two legs, stock plus option, then ask who received the premium. Premium received moves breakeven in the customer's favor and caps the gain. Premium paid moves breakeven against the customer and caps the loss. For moneyness, ask "Would I exercise this right now?" If the answer is yes, the option is in the money. In tax questions, look for the trigger word.
The full lesson (about 4,818 words, 32 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C18
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