SEC Issues Investor Bulletin: An Introduction to Options

The SEC’s Office of Investor Education recently issued an investor bulletin aimed at educating investors about the basics of options trading. Options trading may occur in a several securities marketplaces, and may also involve a diverse range of products, from stocks to foreign currencies. The SEC’s Investor Bulletin titled “An Introduction to Options” focuses on the basics of trading listed stock options.

Options are contracts that allow the owner to buy or sell an underlying asset at a fixed price on or before a specified future date. Options derive their value from the underlying assets. The underlying assets may be stocks, stock indexes, exchange traded funds, fixed income products, foreign currencies or commodities. Additionally, option contracts trade in various securities marketplaces between a variety of market participants, including institutional investors, professional traders and individual investors. Options trades can be for a single contract or for several contracts.

Options trading uses terminology that investors should understand before buying or selling options. The SEC listed some basic terminology below that investors should be familiar with:

  • “Call and “Put”: A call is a type of option contract. A call option is a contract that affords the buyer the right to buy shares of an underlying stock at the strike price during a specific period of time. Alternatively, the seller of the call option is required to sell the shares to the buyer of the call option who exercises his or her option to buy on or before the expiration date. A put option is a contract that affords the buyer the right to sell shares of an underlying stock at the strike price for a specified period of time. Conversely, the seller of the put option is obligated to buy those shares from the buyer of the put option who exercises his or her option to sell on or before the expiration date.
  • “At-the-money”: Indicates that the strike price and the actual price are the same.
  • Exercise: When a buyer invokes his or her right to buy or sell the underlying security, they are “exercising” the right.
  • Assignment: When a buyer exercises his or her right under an option contract, the seller of the option contract receives a notice called an assignment notifying the seller that he or she must fulfill the obligation to buy or sell the underlying stock at the strike price.
  • Holder: The buyer of an options contract is referred to as the “holder” of the contract.
  • Writer: The seller of an options contract is referred to as the “writer” of the contract.

The basics of how options transactions operate are explained below. Many options contracts and trading strategies that are utilized are actually much more complex. However, the SEC provided the following information to investors so that potential investors have a basic idea of how transactions occur.

  • Market Participants: There are generally four (4) market participants in options trading- the buyer of calls; seller of calls; buyers of puts; and sellers of puts.
  • Opening a Position: When you buy or write a new options contract, you are establishing an open position. The open position will then be matched with a buyer or seller on the other side of the contract.
  • Closing a Position: If you hold an options contract or have written an options contract, but then want to get out of the contract, you can close your position, which means either selling the same option you bought if you are a holder or buying the same option contract you sold if you are a writer.

There are several risks associated with trading options. Investors should be aware that it is possible to lose all of your initial investment, and sometimes more. Below is a list of risks the SEC has identified:

  • Option holders risk losing the entire premium paid to purchase the option. If a holder’s option expires “out-of-the-money” the entire premium will be lost.
  • Option writers may carry an even greater level of risk because certain types of options contracts may expose writers to unlimited potential losses.
  • Other risks associated with trading options include market risks because extreme market volatility near an expiration date could cause price changes that result in the option expiring worthless.
  • Option traders also have risks relating to the underlying asset. Since options derive their value from an underlying asset, risk factors that impact the price of the underlying asset will also indirectly impact the price and value of the option.

If you have suffered investment losses as a result of your broker’s or advisor’s options trading strategy, please contact the Hanley Law to explore your legal rights. The Hanley Law is dedicated to helping investors who have been victims of securities and commodities fraud. If you have lost money as a result of options trading, you may be able to recover your financial losses. Contact us today toll free at (239) 649-0050 for a complimentary initial consultation.

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