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2.11 Options Basics

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Securities Industry Essentials SIE

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1 Introduction

About the SIE Exam How to Use This Course

2 Chapter 1: Knowledge of Capital Markets

1.1 Regulatory Bodies 1.2 State Regulation 1.3 Market Participants 1.4 Types of Markets 1.5 The Exchanges 1.6 OTC Markets 1.7 Economic Policies 1.8 Interest Rates 1.9 Business Cycles 1.10 International Economics

3 Chapter 2: Understanding Products and Their Risks

2.1 Common Stock Basics 2.2 Corporate Actions 2.3 Preferred Stock 2.4 ADRs 2.5 Bond Basics 2.6 Yields 2.7 U.S. Treasury Securities 2.8 Corporate Bonds 2.9 Municipal Bonds 2.10 Money Market Instruments 2.11 Options Basics 2.12 Hedging Strategies 2.13 Mutual Funds 101 2.14 Mutual Fund Fees 2.15 ETFs 2.16 UITs & REITs 2.17 DPPs 2.18 Systematic Risk 2.19 Non-Systematic Risk 2.20 Mitigation Strategies

4 Chapter 3: Trading, Customer Accounts and Prohibited Activities

3.1 Order Types 3.2 Trade Settlement 3.3 Quoting 3.4 Account Types 3.5 Account Registration 3.6 Retirement Plans 3.7 Education Savings 3.8 AML Rules 3.9 Market Manipulation 3.10 Insider Trading 3.11 Customer Protection

5 Chapter 4: Overview of Regulatory Framework

4.1 Registration 4.2 Continuing Education 4.3 Employee Conduct 4.4 Correspondence

2.11 Options Basics

Key Takeaways Explain This Topic AI

Call options give buyers the right to buy at strike price (bullish); put options give buyers the right to sell at strike price (bearish)

Option premium = Intrinsic Value + Time Value, with time value decaying to zero at expiration

Call intrinsic value = Market Price - Strike Price; Put intrinsic value = Strike Price - Market Price (if positive)

Calls are in-the-money when market price > strike price; puts are in-the-money when market price < strike price

  • Option buyers have rights; option sellers (writers) have obligations
  • Last updated: January 2026

Options are derivative securities that give holders the right—but not the obligation—to buy or sell an underlying asset at a specified price before a certain date. While the SIE exam covers options at a basic level, understanding key concepts like calls, puts, premiums, and intrinsic value is essential.

What Is an Option?

An option is a contract that gives the buyer the right (not obligation) to buy or sell an underlying security at a predetermined price within a specific time frame.

Key Option Components

  • Component Description
  • Underlying asset The security the option is based on (usually stock)
  • Strike price The price at which the option can be exercised
  • Expiration date The date the option contract expires
  • Premium The price paid to purchase the option
  • Calls vs. Puts

There are two types of options:

Call Options

A call option gives the buyer the right to buy the underlying security at the strike price.

  • Buyer (holder) : Has the right to buy
  • Seller (writer) : Has the obligation to sell if exercised
  • Bullish : Buyers expect the price to rise

Memory Tip: "Call up" — You call to buy something and want prices to go up.

Put Options

A put option gives the buyer the right to sell the underlying security at the strike price.

  • Buyer (holder) : Has the right to sell
  • Seller (writer) : Has the obligation to buy if exercised
  • Bearish : Buyers expect the price to fall

Memory Tip: "Put down" — You put (sell) something and want prices to go down.

Rights vs. Obligations

  • Position Call Option Put Option
  • Buyer Right to buy Right to sell
  • Seller Obligation to sell Obligation to buy
  • Option Premium

The premium is the price paid by the buyer to the seller for the option contract. Premium = Intrinsic Value + Time Value \text{Premium} = \text{Intrinsic Value} + \text{Time Value} Premium = Intrinsic Value + Time Value

Intrinsic Value

Intrinsic value is the amount by which an option is "in the money"—the built-in profit if exercised immediately.

For Call Options: Intrinsic Value = Market Price − Strike Price (if positive) \text{Intrinsic Value} = \text{Market Price} - \text{Strike Price} \text{ (if positive)} Intrinsic Value = Market Price − Strike Price (if positive)

For Put Options: Intrinsic Value = Strike Price − Market Price (if positive) \text{Intrinsic Value} = \text{Strike Price} - \text{Market Price} \text{ (if positive)} Intrinsic Value = Strike Price − Market Price (if positive)

Example: Stock trades at $55. A call with a $50 strike has intrinsic value of $5 ($55 - $50). A put with a $60 strike has intrinsic value of $5 ($60 - $55).

Time Value (Extrinsic Value)

Time value is the portion of the premium above intrinsic value. It reflects the possibility that the option could become more valuable before expiration.

  • More time until expiration = More time value
  • As expiration approaches, time value decays toward zero
  • At expiration, an option has no time value—only intrinsic value (if any)
  • In, Out, and At the Money

Options are classified by the relationship between the strike price and market price:

Call Options

  • Status Condition Intrinsic Value
  • In the money (ITM) Market price > Strike price Has value
  • At the money (ATM) Market price = Strike price Zero
  • Out of the money (OTM) Market price < Strike price Zero
  • Put Options
  • Status Condition Intrinsic Value
  • In the money (ITM) Market price < Strike price Has value
  • At the money (ATM) Market price = Strike price Zero
  • Out of the money (OTM) Market price > Strike price Zero

Key Point: Only in-the-money options have intrinsic value. Out-of-the-money options have only time value.

  • Exercise Styles
  • American Style

American-style options can be exercised at any time before expiration.

  • Most equity (stock) options are American-style
  • More flexibility for the holder
  • Generally more valuable than European-style
  • European Style

European-style options can only be exercised at expiration .

  • Most index options are European-style
  • Less flexibility for the holder
  • Cannot be exercised early
  • Standard Contract Size

One equity option contract typically represents 100 shares of the underlying stock.

Example: If you buy 1 call option for a $2 premium, you pay $200 total ($2 × 100 shares). This gives you the right to buy 100 shares at the strike price.

Option Positions Summary

  • Position Market View Maximum Gain Maximum Loss
  • Buy call Bullish Unlimited Premium paid
  • Sell call Neutral/Bearish Premium received Unlimited
  • Buy put Bearish Strike price - Premium Premium paid
  • Sell put Neutral/Bullish Premium received Strike price - Premium
  • Key Takeaways
  • Calls give the right to buy; puts give the right to sell
  • Buyers have rights; sellers have obligations
  • Premium = Intrinsic value + Time value
  • In-the-money options have intrinsic value
  • Time value decays as expiration approaches
  • American options can be exercised anytime; European only at expiration
  • One standard contract = 100 shares