Options – Investors' Academy

Options work with leverage. Because of the leverage effect, the profit you can make from an option is greater in percentage terms than if you were to invest directly in the underlying asset. This is because you need to invest a smaller amount for an option than for a direct investment in the underlying asset, while the chances of making a profit remain the same. Depending which direction of movement you want to bet on, you can lose a lot of money quickly and often with options when it moves in the other direction – much faster and in larger amounts than through a direct investment in the underlying asset. For example, if the price of the underlying asset remains more or less the same, the option will lose its value more quickly as time passes, and expire with zero value on the expiration date of the option. If you invest directly in the underlying asset, your investment simply remains at approximately the same value.

There are two types of options: call options and put options. When you buy them, you are buying a right. You can read more about entering into an obligation (writing options) in '5. Writing options'.

Buying a call option

When you buy a call option, you pay a premium. This entitles you to buy a certain quantity of an underlying asset at a predetermined price during a certain period.

Buying a put option

When you buy a put option, you pay a premium. This entitles you to sell a certain quantity of an underlying asset at a predetermined price during a certain period.

You decide for yourself whether you wish to make use of this right. If you do use it, we call it exercising.

Exercise price

The predetermined price is called the exercise price.

Expiration date

The day that the option expires is the expiration date. This is always defined in advance.

Expiration time

The time that the option expires is called the expiration time.

Exercise period

The period until the expiration date of the option is called the exercise period. Options have different exercise periods. The most common are monthly options, where the expiration date is the third Friday of the month. However, there are also weekly and even daily options.

Premium

The price of an option is called the premium.

Contract volume

The volume of the underlying asset of the option is always determined in advance. In the case of a share option, the contract volume is usually 100: you can buy or sell 100 under one option. For an index option, the contract size is always 100: if the index changes by one point, you will receive or pay €200.

Exposure

The exposure indicates the extent to which your portfolio is exposed to changes in the market. The exposure value serves as a type of risk gauge to assess whether your portfolio aligns with the associated risk profile. You can add risk or reduce it through exposure.

The price of an option is called a premium and consists of two parts:

Its time and expectation value

This part of the premium indicates what the market expects the price of the underlying asset to do. The market takes into account the remaining time until the end date of the option, the expiration date. On the expiration date, the time and expectation value is virtually zero.

Its intrinsic value

The intrinsic value is the difference between the exercise price and the price of the underlying asset. An option has intrinsic value when the price of the underlying asset exceeds the exercise price of a call option, or when the price of the underlying asset is lower than the exercise price of a put option. The intrinsic value can never drop below zero.

If the price of the underlying asset rises:

• The premium of a call option on the underlying asset will also generally rise; and
• The premium of a put option on the underlying asset will generally fall.

If the price of the underlying asset falls:

• The premium of a call option on the underlying asset will also generally fall; and
• The premium of a put option on the underlying asset will generally rise.

A special feature of options is that you can sell an option without holding a position in it. You then have a negative position. Selling is known as writing, and a negative position is known as a short position. If you write an option, you don't have a right, but instead an obligation:

If you write a call option

You will receive the premium. This means that you are obliged to deliver a certain volume of an underlying asset at the exercise price during the exercise period.

If you write a put option

You will receive the premium. This means that you are obliged to buy a certain volume of an underlying asset at the exercise price during the exercise period.

You can use covered and uncovered writing.

Covered writing

With covered writing, you have the underlying asset in your investment portfolio and write it on the basis of this cover. Example: You have 200 Philips shares and write two Philips call options on these. If you have to comply with your obligation at any time and deliver the shares, you can deliver these 200 shares whenever necessary. This happens automatically, so you don't have to issue any instructions yourself.

Uncovered writing

If you use uncovered writing, you do not have the underlying asset in your investment portfolio. Let's take the same example: If you have to comply with your obligation at any time and deliver 200 Philips shares, you can't do it. You first need to buy the shares on the stock exchange and then deliver them in the same way. This will also happen automatically.

If you write put options, they are always uncovered. When you write a put option, you have to purchase the underlying asset. Suppose you have written two Philips put options and you have to fulfil your obligation at some point? You then buy 200 Philips shares at the exercise price, which also takes place automatically.

Margin

To ensure that you can meet your obligations to cover your uncovered written options, you must hold a certain balance in your account. We call this amount the margin. The margin is not a fixed amount, but can change daily depending on the premium, among other things. If your margin is too low, your orders cannot be executed.

Options can end in different ways.

You have purchased an option

If you have purchased an option, your option may end by:

• you exercising your option;
• you closing your option (closing sale); or
• your option expiring with no value on the expiration date.

You have written an option

If you have written an option, your option may end by:

• your option being assigned. A buyer then exercises their right and you, as the seller (writer), then need to fulfil your obligation. This need not take place purely on the expiration date – it can also occur earlier in the exercise period;
• you closing your option (closing sale); or
• your option expiring with no value on the expiration date.

'American' or 'European' style

American-style options can be exercised throughout the entire term of the option. These are usually share options. European-style options can only be exercised on the expiration date. These are usually index options. In addition, settlement for American-style options generally occurs physically (in the underlying asset itself), while European-style options settle in cash.

Whether an option has value is indicated using the following terms: 'In the money', 'Out of the money' and 'At the money'.

In the money

This means that the price of the underlying asset is higher than the exercise price of a call option, or that the price of the underlying asset is lower than the exercise price of a put option. The option has a positive value for the investor at that point. The premium then consists mainly of the intrinsic value, and to a lesser extent of the time and expectation value.

Out of the money

This means that the price of the underlying asset is lower than the exercise price of a call option, or that the price of the underlying asset is higher than the exercise price of a put option. The option has a negative value for the investor at that point. The premium consists entirely of the time and expectation value.

At the money

This means that the price of the underlying asset is approximately the same as the exercise price of the option. The premium consists solely of the time and expectation value, which may start slightly higher than the time and expectation value of an option that is out of the money.

Making a profit or loss depends on a number of factors:

If you buy an option, your maximum profit is:

• the positive difference between the price of the underlying asset and the exercise price;
• less the premium you paid; and
• less the fees you paid.

If you buy an option, your maximum loss is:

• the premium you paid;
• plus the fees you paid.

If you write (sell) an option, your maximum profit is:

• the premium you received;
• less the fees you paid.

If you write (sell) an option, your maximum loss is:

• the negative difference between the price of the underlying asset and the exercise price. For a call option, this difference is theoretically infinite;
• plus the fees you paid;
• less the premium you received.