Options Trading Study Questions

These flashcards cover key aspects of options trading, providing essential definitions, concepts, and strategies crucial for understanding options and preparing for exams in finance.

What is an option?

A contract granting the right (but not the obligation) to buy or sell an underlying stock at a specified strike (exercise) price.

Is an option buyer obligated to transact by expiration?

No, the buyer has a right, not an obligation, to exercise by the deadline.

What is a call option?

A call gives the right to BUY an asset at a set price before expiration; used when expecting the stock to rise.

What is a put option?

A put gives the right to SELL an asset at a set price before expiration; used when expecting the stock to fall.

What does 'a buyer is not obligated' mean?

The buyer can choose whether to exercise and can let an option expire if it is not beneficial.

What obligation does the seller (writer) of an option have?

The seller must fulfill the contract if assigned at or before expiration.

What is a call buyer’s position?

The call buyer has the choice to buy the underlying at the strike by the deadline.

What is a put buyer’s position?

The put buyer has the choice to sell the underlying at the strike by the deadline.

What is a call seller’s obligation?

The call seller must sell shares at the strike if assigned and keeps the premium received.

What is a put seller’s obligation?

The put seller must buy shares at the strike if assigned and keeps the premium received.

What can you do at Options Approval Level 1?

Sell covered calls.

What can you do at Level 2?

Buy calls, buy puts, buy strangles/straddles/collars, and sell cash-secured puts.

What can you do at Level 3?

Trade credit and debit spreads.

What can you do at Level 4?

Sell 'naked' puts, straddles, and strangles.

What can you do at Level 5?

Sell 'naked indexed' options and 'index spreads.'

What is the strike (exercise) price?

The pre-agreed price per share at which the stock may be bought or sold under the option contract.

What are the bid and ask?

The ask is the latest price a seller is willing to accept; the bid is the latest price a buyer is willing to pay.

What is the option premium?

The per-share price paid by the buyer to the seller for the option.

What does In-the-Money (ITM) mean?

For calls, stock price > strike; for puts, stock price < strike. The option has intrinsic value.

What does Out-of-the-Money (OTM) mean?

For calls, stock price < strike; for puts, stock price > strike. OTM options have no intrinsic value.

What does At-the-Money (ATM) mean?

The strike price is approximately equal to the current stock price.

What does 'long' mean in options context?

You own the option or stock; being long reflects ownership.

What does 'short' mean in options context?

You have sold an option or stock you do not own; you are short that security.

What is exercising an option?

The option owner uses their right to buy (call) or sell (put) the underlying at the strike price.

What does it mean to be assigned?

The seller is required to fulfill the contract—sell shares on a call assignment or buy shares on a put assignment.

What are intrinsic value and time value?

Intrinsic value is how much an option is ITM; time value reflects remaining time until expiration.

What is time decay?

The gradual reduction of time value as expiration approaches.

How do index options differ from equity options?

Index options are cash-settled and usually cannot be exercised early; equity options involve stock settlement.

What is a stop-loss order?

An order that converts to a market order once a specified stop price is reached.

Which stocks should you avoid or prefer for option trading?

Avoid illiquid penny stocks; favor large, liquid names like Microsoft or Apple.

How many shares does one option contract control?

100 shares of the underlying.

What fundamental skill should you develop for options success?

Study the market deeply to better forecast direction and timing.

What should a beginner start with?

Trading stocks before advancing into options.

Why is the strike price crucial in every options trade?

If the stock never reaches the strike, the option expires worthless.

What does the spread between current price and strike represent?

The per-share profit potential if the trade works as intended.

When can you execute based on strike?

If a stock hits the strike price, that right to trade at the strike is meaningful.

How do you calculate an option’s potential value?

Value ≈ current price minus strike.

What is an options payoff diagram?

A visual showing profit/loss versus stock price at expiration.

What is a covered call?

Selling a call against shares you already own.

What is one advantage of a covered call regarding taxes?

Can be done in a tax-deferred IRA account.

What are the two possible outcomes at expiration for a covered call?

Either option expires and you keep shares/premium, or option is exercised and you sell shares.

What is the FIRST step of a covered-call process?

Choose a stock you own that's been performing well.

What is the SECOND step of a covered-call process?

Pull up the stock’s option chain to see available bids/asks.

What is the THIRD step of a covered-call process?

Review premiums; one contract pays premium × 100 shares.

What is the FOURTH step of a covered-call process?

Focus on expirations a few months out for higher premiums.

What is the FIFTH step of a covered-call process?

Compare bid vs. ask to determine selling strategy.

What is the SIXTH step of a covered-call process?

Identify which options are ITM.

What is the SEVENTH step of a covered-call process?

Prefer slightly OTM strikes to target selling above today’s price.

What is the EIGHTH step of a covered-call process?

Consider slightly ITM strikes if the premium compensates for selling below market.

What is the NINTH step of a covered-call process?

Enter the order and wait for expiration results.

What order 'Action' do you use to sell a covered call?

'Sell to Open,' then specify the number of contracts.

Should you use a market or limit order for selling covered calls?

A limit order is usually better for controlling price.

For how long should the order remain active?

Prefer 'Day' to relist with updated info if it doesn’t fill.

How should you set your limit price?

Use current bid/ask as guides.

What completes the covered-call listing process?

Submit the order—your covered call is now live awaiting a buyer.

What market environment best suits covered-call selling?

Flat or gently moving markets.

What kind of underlying stocks fit covered-call strategy?

Slow, steady movers; avoid highly volatile names.

How should you think about the premium for covered calls?

Premium is the guaranteed part of the trade; set a minimum acceptable premium.

How should you choose an expiration for covered calls?

Prefer roughly 1–3 months for expiration.

How should you choose the strike for a covered call?

Think like the buyer; combine comfort with strike and premium.