1.1 Basic Definitions and Mechanics

Options contracts are derivative instruments that give you the right to buy or sell an underlying instrument for a given price at a later date. The underlying instruments can be anything: equity stocks, bonds, futures, swaps, etc. This user documentation will focus primarily on equity stocks of publicly traded companies that are listed on public stock exchanges like the Nasdaq or New York Stock Exchange (NYSE). We assume you already understand what stocks are, how they are valued, and how they are traded.

An option contract is defined by a couple of parameters. First, the strike of the contract is the price you can buy or sell the underlying at the contract expiration date (commonly referred to as expiry). The option to buy the underlying stock is referred to as a call option (it gives you the right to call stock away from the seller of the contract for the given strike price), and the option to sell the underlying stock is known as a put option (it gives you the right to put the stock on the contract seller for a given strike price). Importantly, each option contract price is quoted in price per share, but are written for trading blocks of 100 shares. For example, a SPY call option with strike of $600 and a price of $5.00 actually costs $500 to buy, and gives you the right to purchase 100 shares of SPY for $60,000.

All options contracts have a buyer and a seller (otherwise known as the contract writer). Like on the stock exchange, options trading is mediated by entities called market makers, who set prices on the exchange at which they would be willing to take the other side of every trade. This means that there is always an active bid and ask on the market. For example, if all participants only want to buy calls, the market maker would be the seller of last resort, taking on the burden of being at risk of having stock shares called away. Market makers hedge this risk by trading the underlying, and this mechanic is the basis for many of the tools developed on Gammastrike. We will return to the concept of hedging in more detail later on.

All options contracts come with an expiration date, which can range from the same day of purchase to years into the future. Stock options that expire on the same day are colloquially named 0dtes (zero days to expiry), pronounced “zero dee-tee-ees”, and those expiring next Friday are weeklies. Each 3rd Friday of the month is designated the monthly options expiration date (OpEx). Market participants often make special note of OpEx dates that align with quarterly expirations of Futures and other large, long term instruments, which are March, June, September, and December. Finally, long term expiration anticipation securities (LEAPS) are contracts that expire each year on January OpEx. Although the expiration date on stock options is the last opportunity to exercise, you may also choose to exercise your contract at any time before the expiration date, or early exercise. These types of contracts are called American style options, and all equity stock options are of this type. There is no rigorously recognized advantage to exercising calls before expiration, but there are a few strategies where exercising puts early can increase returns. Regardless, you may trade your option to another market participant at any time before expiration.

In addition to stock options, there are also options on stock indexes. For example, options on the price of the S&P 500 are traded under the ticker SPX and SPXW, and the Nasdaq 100 is traded under the ticker NDX. Unlike traditional stock options, there are no underlying shares that make up an index, so these contracts are only cash settled at expiration (no stock changes hands). These should not be confused with index exchange traded funds (ETFs), such as SPY and QQQ, which do have underlying shares and have the same rules as single company stock options. Index options are European style contracts, meaning they can only be exercised at expiry (though like American options can still be traded at any time). The expiration schedule for index options differ from single stock options. For SPX and NDX, the monthly OpEx contracts expire at 9:30 AM EST on that Friday expiration (known as AM expiry), but cannot be traded after 4:15 PM EST the day before. This means that there is a window in which the value of the contract can change but you cannot trade the contract. SPX also has weekly contracts under the ticker SPXW. These contracts expire at 4:00 EST and are also European style and cash settled.