Frequently Asked Questions: Options
What is an option?
An option contract is a security that gives its buyer the right to buy (a call option) or sell (a put option) a predetermined quantity of the underlying security at a fixed price on or before a specified date in the future.
What is a call option and what is a put option?
A call option gives the buyer the right to purchase the underlying security at a set price (the "strike price") on or before the expiration date. If you are short a call option and it is exercised by the buyer, then you have an obligation to sell the underlying security at the strike price. A put option gives the buyer the right to sell the underlying security at the strike price on or before the expiration date. If you are short a put option and it is exercised by the buyer, then you have an obligation to purchase the underlying security at the strike price.
Why do I need approval for option trading?
Firms have a regulatory responsibility to try to determine that investments are suitable for their customers. Options involve risk and are not suitable for all investors. As such, Vision requires investors to complete and sign a separate application for options trading which is available here.
How do I get approval for option trading?
In order to be approved to trade options, Vision requires customers to complete our Options Supplement to determine suitability. In addition, investors should carefully read the options risk disclosure document entitled Characteristics and Risks of Standardized Options (with 1997 through May 2010 supplement), January 2011 and March 2011 Supplement to Characteristics and Risks of Standardized Options.
What are the different Option Levels for trading available through Vision?
There are different option levels available through Vision which offer the following capabilities:
- Level 1 includes covered writing of equity calls;
- Level 2 includes Level 1 and the purchase of equity and index calls and puts, index straddles or combinations;
- Level 3 includes Level 2 and equity spreads plus covered writing of equity puts;
- Level 4 includes Level 3 plus uncovered writing of equity calls, puts, straddles or combinations; and
- Level 5 includes Level 4 and uncovered writing of index calls, puts, index spreads, straddles or combinations.
Please be aware that Individual Retirement Accounts are eligible only for Levels 1 and 2. In addition, Levels 3, 4 and 5 require a signed Margin Supplement to be submitted to Vision. Whichever Level you may request for your account needs to be reviewed by a Registered Options and Security Futures Principal at Vision before the request can be granted.
What is a covered call?
A covered call is an options strategy where an investor owns an underlying long position and writes (i.e. sells) call options on that position. This strategy can be used to generate income and/or to provide limited downside protection on a long position. If the option contract expires worthless, the investor keeps the entire premium and can sell a new call option on the underlying position. If the call option is exercised, the investor will need to deliver the long shares to meet the exercise requirement.
Am I allowed to write uncovered calls?
Writing uncovered calls is extremely risky. If you write an uncovered call and the price of the underlying security keeps rising above the strike price of the option there is no limit to how much money you can lose. As such, uncovered calls require a Level 4 Option Trading approval.
What is meant when an option is said to be "naked?"
If an investor sells a call option without owning the underlying stock or sells a put option without also purchasing a put option at a lower strike price (creating a spread transaction), then the resulting position is said to be "naked." A naked option entails a high level of risk as the potential for loss on a naked call is unlimited and can be very high on a naked put (though not unlimited since the underlying stock can not go below a price of zero).
What is meant by an option being "in-the-money," "out-of-the-money", or "at-the-money?"
An option is in-the-money if the strike price of a call is below the underlying security price or the strike price of a put is higher than the underlying security price. Out-of-the-money is when a call option's strike price is higher than the underlying security price or a put option's strike price is lower than the underlying security price. At-the-money means the options strike price for a put or a call is the same price as the underlying security.
What is a spread order?
A spread is an options strategy involving two transactions, usually executed at the same time. An investor purchases one option and writes (i.e. sells) another option on the same underlying stock or index. Both options are the same except for one aspect such as the strike price or expiration month. Investors should consult with their tax advisor regarding the potential tax consequences. Investors will pay commission on each leg of the spread transaction.
What is a straddle?
A straddle involves buying a call and a put or selling a call and a put with the same underlying security, exercise price and expiration date. The buyer of a straddle expects a significant movement (in either direction) in the underlying security. The seller of a straddle is anticipating the underlying price to remain stable. The risks of straddles are similar to those of uncovered options. If either leg of the option is exercised there is a risk of substantial loss.
What is a strangle?
A strangle involves buying a call and a put or selling a call and a put with the same expiration date, but different strike prices which are both out-of-the-money. A buyer of a strangle anticipates a large movement (in either direction) in the underlying security. The seller of a strangle anticipates no large movement.
What is a LEAP?
A Long-Term Equity Anticipation Security ("LEAP") is an option contract for which the expiration is greater than one year (most option contracts are less than one year). Everything else regarding the mechanics of the contract is the same compared to a non-LEAP. However, the premium on a LEAP tends to be higher than non-LEAPs due to the greater time value associated with these options.
What are the commissions for option trading?
Trading options at Vision costs $6.00 plus $0.75 per contract (plus any exchange fees such as pass-through costs for index options) for both market and limit orders with no minimum amount required.
How do I exercise my option contract?
To exercise your long option contract you must contact Vision's Client Services team at 1.877.836.3949. You will need to provide the number of contracts you would like to exercise, the symbol, month, and strike price of the contract(s) to exercise. Please contact us at the latest by 4:15 PM ET on the day before expiration. Please note that requests received after 3:30 PM ET will be processed on a best efforts basis.
What happens if I do not exercise my options contract?
If your position at expiration is in-the-money then all option contracts that are within a set threshold will be automatically exercised. For a single stock option to be automatically exercised, it must be in-the-money by at least $0.05. For an index option to be automatically exercised it must be in-the-money by at least $0.01. If these criteria are not met, the option will expire worthless. However, if a customer would like to exercise an option, even though the contract is not in-the-money by this minimum threshold (or is even out-of-the money), contrary instructions must be communicated to Vision's Client Services team at 1.877.836.3949 at the latest by 4:15 PM ET on the day before expiration. All requests received after 3:30 PM ET will be processed on a best efforts basis.
When do option contracts expire?
All equity options and index options expire at 11:59 PM ET on the Saturday following the third Friday of the expiration month. An expiring option will stop trading at 4:00 PM ET on the business day before the expiration day.
Is there a commission or other charge for an option that expires worthless?
There is no commission charge for an option that expires worthless. However, if you exercise an option contract which is long or are assigned on a contract on which you are short, the resulting event is a transaction that will entail a corresponding commission charge. For example, if you are long one call option and exercise that contract, the resulting purchase of 100 shares of the underlying security (in the case of a stock option) will cost you $7.00 ($6.00 plus $0.01 per share).
What is the difference between American and European styles of options?
The American Style of options allows option contracts to be exercised at any time up to the day before expiration. The European style of options may be exercised only during a specific period of time which is usually the day before expiration.
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