A Simplified Wall Street Journal Quotation for a Chicago Board Options Exchange (CBOE) Stock Option

An option is a contract that gives its owner the right to buy or sell some asset at a fixed price on or before a given date. For example, an option on a building might give the holder of the option the right to buy the building for $1 million anytime on or before the Saturday prior to the third Wednesday of January 2010.

Options are a unique type of financial contract because they give the buyer the right, but not the obligation, to do something. The buyer uses the option only if it is profitable to do so; otherwise, the option can be thrown away.

There is a special vocabulary associated with options. Here are some important definitions:

1. Exercising the option. The act of buying or selling the underlying asset via the option contract is called exercising the option.
2. Strike price, or exercise price. The fixed price specified in the option contract at which the holder can buy or sell the underlying asset is called the strike price or exercise price. The strike price is often called the striking price.
3. Expiration date. An option usually has a limited life. The option is said to expire at the end of its life. The last day on which the option may be exercised is called the expiration date.
4. American and European options. An American option may be exercised anytime up to and including the expiration date. A European option may be exercised only on the expiration date.

Puts and Calls

Options come in two basic types: puts and calls. A call option gives the owner the right to buy an asset at a fixed price during a particular time period. It may help you to remember that a call option gives you the right to “call in” an asset.

A put option is essentially the opposite of a call option. Instead of giving the holder the right to buy some asset, it gives the holder the right to sell that asset for a fixed exercise price. If you buy a put option, you can force the seller of the option to buy the asset from you for a fixed price and thereby “put it to them.”

What about an investor who sells a call option? The seller receives money up front and has the obligation to sell the asset at the exercise price if the option holder wants it. Similarly, an investor who sells a put option receives cash up front and is then obligated to buy the asset at the exercise price if the option holder demands it. An investor who sells an option is often said to have “written” the option.

The asset involved in an option can be anything. The options that are most widely bought and sold, however, are stock options. These are options to buy and sell shares of stock. Because these are the best-known types of options, we will study them first. As we discuss stock options, keep in mind that the general principles apply to options involving any asset, not just shares of stock.

Stock Option Quotations

On April 26, 1973, the Chicago Board Options Exchange (CBOE) opened and began organized trading in stock options. Put and call options involving stock in some of the  best-known corporations in the United States are traded there. The CBOE is still the largest organized options market, but options are traded in a number of other places today, including the New York, American, and Philadelphia stock exchanges. Almost all such options are American (as opposed to European).

A simplified Wall Street Journal quotation for a CBOE option might look something like this:

The first thing to notice here is the company identifier, RWJ. This tells us that these options involve the right to buy or sell shares of stock in the RWJ Corporation. Just below the company identifier is the closing price on the stock. As of the close of business on the day before this quotation, RWJ was selling for $100 per share.

The second column shows the strike price. The RWJ options listed here have an exercise price of $95. Next, we have the expiration months (June, July, and August). All CBOE options expire on the third Friday of the expiration month.

The remaining four columns give volume (Vol.) and price (Last) information for call options and then put options. The volume information tells us the number of option contracts that were traded that day. One contract involves the right to buy or sell 100 shares of stock, and all trading actually takes place in contracts. Option prices, however, are quoted on a per-share basis.

For example, the first option listed would be described as the “RWJ June 95 call.” The price for this option is $6. If you pay the $6, then you have the right anytime between now and the third Friday of June to buy one share of RWJ stock for $95. Because trading takes place in round lots (multiples of 100 shares), one option contract costs you $6 × 100 = $600.

The other quotations are similar. For example, the July 95 put option costs 2⁸⁰, or $2.80. If you pay $2.80 × 100 = $280, then you have the right to sell 100 shares of RWJ stock anytime between now and the third Friday in July at a price of $95 per share.

—Stephen A. Ross, Randolph W. Westerfield, and Bradford D. Jordan, Fundamentals of Corporate Finance, 6th ed. Alternate ed. (New York: McGraw-Hill Irwin, 2003), 454-455.