An option is a financial instrument that gives you the right, but not the obligation, to buy or sell an underlying market (eg the S&P 500 index) at a certain price on a certain date.
A call option gives you the right to buy the underlying market at a certain price (the strike price) on or before a certain date (the expiry date).
A put option gives you the right to sell the underlying market at a certain price (the strike price) on or before a certain date (the expiry date).
The strike price (also called exercise price) is the set price in an options contract at which the underlying market can be bought (when it’s a call option) or sold (when it’s a put option).
The end of life of an option. On this date, you’d either need to execute your trade or it would expire, and become worthless.
The price that you’ll pay to buy an option, or the money you’d receive to sell an option.
In-the-money (ITM) option
An in-the-money option is a contract that will earn a profit if exercised today. A call is ITM when the underlying market price is above the call’s strike price. A put is ITM when the underlying market price is below the put’s strike price.
At-the-money (ATM) option
An option is ATM when the underlying market price is at (or very close to) the option’s strike price.
Out-of-the-money (OTM) option
An out-of-the-money option would earn a loss if it was executed today. A call is OTM when the underlying market price is below the call’s strike price. A put is OTM when the underlying market price is above the put’s strike price.
The Greeks is a term used in the options markets to describe the different risk parameters involved in taking an options position. There are five main Greeks: Delta, Gamma, Vega, Theta and Rho.
Delta represents the sensitivity of an option's price to a change in the underlying market price.
Gamma represents the sensitivity of an option's delta to a change in the underlying market price.
Vega represents the sensitivity of an option's price to a change in implied volatility.
Theta represents the sensitivity of an option's price to a change in time until the option’s expiry.
Rho represents the sensitivity of an option's price to a change in interest rates.
Intrinsic value is the amount by which an option is in the money. For a call the intrinsic value is the underlying market price minus the call’s strike price. For a put the intrinsic value is the put’s strike price minus the underlying market price.
Extrinsic value is the difference between an option’s premium and its intrinsic value. The premium of an out-of-the-money option will be all extrinsic value (because the intrinsic value of an OTM option is zero).
Implied volatility is the market’s view on likely movement in the price of an option, as calculated using the Black Scholes or similar option pricing model.
Historical volatility (or simply ‘actual’ volatility) is the measure of the distribution of returns for a given underlying market using historical data.
Take the next step toward trading options
Learn more about options trading with our complete guide to options contracts, or get started trading in just a few steps:
- Learn how to use spread bets and trade CFDs
- Create an account with City Index
- Find the options market you want to trade
- Choose between a call or put option
- Open your position
- Monitor and close your trade
Get started trading on live markets, or practise trading first in a risk-free demo account
Use the search bar in our award-winning platform to quickly find your market
Decide whether you think the market will rise or fall, and choose a strike price to ‘buy’ or ‘sell’ at
Enter the market by clicking ‘place a trade’, you may want to consider adding a stop loss to your trade to manage your risk
Use analysis to stay up to date with any price movements and identify an exit point for your position