Options involve risk and are not suitable for all investors. [+] Show details and the options disclosure document.
Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.
The maximum loss, gain and breakeven of any options strategy only remains as defined so long as the strategy contains all original positions. Trading, rolling, assignment, or exercise of any portion of the strategy will result in a new maximum loss, gain and breakeven calculation, which will be materially different from the calculation when the strategy remains intact with all of the contemplated legs or positions. This is applicable to all options strategies inclusive of long options, short options and spreads. To learn more about Merrill's uncovered option handling practices, view
Naked Option Stress Analysis (NOSA) (PDF).
Early assignment risk is always present for option writers (specific to American-style options only). Early assignment risk may be amplified in the event a call writer is short an option during the period the underlying security has an ex-dividend date. This is referred to as dividend risk.
Long options are exercised and short options are assigned. Note that American-style options can be assigned/exercised at any time through the day of expiration without prior notice. Options can be assigned/exercised after market close on expiration day. View specific
Merrill Option Exercise & Assignment Practices (PDF).
Supporting documentation for any claims, comparison, recommendations, statistics, or other technical data, will be supplied upon request.
An option's premium is comprised of intrinsic value and extrinsic value. Intrinsic value is reflective of the actual value of the strike price versus the current market price. Extrinsic value is made up of time until expiration, implied volatility, dividends and interest rate risks.
Intrinsic Value (Calls)
A call option is in-the-money when the underlying security's price is higher than the strike price.
For illustrative purposes only.
Intrinsic Value (Puts)
A put option is in-the-money if the underlying security's price is less than the strike price.
For illustrative purposes only.
Only in-the-money options have intrinsic value. It represents the difference between the current price of the underlying security and the option's exercise price, or strike price. Essentially, intrinsic value exists if the strike price is below the current market price in regard to calls and above for puts.
Time Value
Time value is any premium in excess of intrinsic value before expiration. Time value is often explained as the amount an investor is willing to pay for an option above its intrinsic value. This amount reflects hope that the option's value increases before expiration due to a favorable change in the underlying security's price. The longer the amount of time available for market conditions to work to an investor's benefit, the greater the time value. Time value is also referred to as extrinsic value as other factors influence an option's premium outside of intrinsic value.
For illustrative purposes only.
Major Factors Influencing Options Premium
Factors having a significant effect on options premium include:
- Underlying price
- Strike
- Time until expiration
- Implied volatility
- Dividends
- Interest rate
Dividends and risk-free interest rate have a lesser effect.
Changes in the underlying security price can increase or decrease the value of an option. These price changes have opposite effects on calls and puts. For instance, as the value of the underlying security rises, a call will generally increase. However, the value of a put will generally decrease in price. A decrease in the underlying security's value generally has the opposite effect.
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A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security.
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A call option is out of the money if the strike price is greater than the market price of the underlying security. A put option is out of the money if the strike price is less than the market price of the underlying security.
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An option is at the money if the strike price of the option is equal to the market price of the underlying security.
The effect of implied volatility is subjective and difficult to quantify. It can significantly affect the time value portion of an option's premium. Volatility is a measure of risk (uncertainty), or variability of price of an option's underlying security. Higher volatility estimates indicate greater expected fluctuations (in either direction) in underlying price levels. This expectation generally results in higher option premiums for puts and calls alike. It is most noticeable with at-the-money options.
The effect of an underlying security's dividends and the current risk-free interest rate has a small but measurable effect on option premiums. This effect reflects the cost to carry shares in an underlying security. Cost of carry is the potential interest paid for margin or received from alternative investments (such as a Treasury bill) and the dividends from owning shares outright. Pricing takes into account an option's hedged value so dividends from stock and interest paid or received for stock positions used to hedge options are a factor.
Content licensed from the Options Industry Council is intended to educate investors about U.S. exchange-listed options issued by The Options Clearing Corporation, and shall not be construed as furnishing investment advice or being a recommendation, solicitation or offer to buy or sell any option or any other security. Options involve risk and are not suitable for all investors.
Content licensed from the Options Industry Council. All Rights Reserved. OIC or its affiliates shall not be responsible for content contained on Merrill's Website, or other Company Materials not provided by OIC. OIC education can be accessed at the
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Without the Jargon
An option is a derivative of its underlying security and is comprised of contract terms. The price of the option will increase in value if the terms of the contract are more favorable than the market and if there is anticipation or more time for this to occur.
For example, 1 ABC $100.00 Call represents the right to purchase 100 shares of ABC at $100.00 at any time up to the expiration date. If ABC increases to $105.00, the call will be worth at least $5.00 – because the buyer can exercise their rights to buy 100 shares at $100.00 and immediately sell at the market for $105.00 capturing a $5.00 per share profit. If ABC rises to $110.00, the call will be worth at least $10.00. If ABC decreases to $95.00 per share, the call will not have any intrinsic value because it is more favorable to purchase the shares at the market rather than the strike price of $100.00.
Time will also influence the premium of the option. The longer the contract has until expiration, the more expensive it will be as the holder has more time for the stock to move above or below the strike price. Implied volatility is a metric that rises when there is anticipation for the underlying security to move drastically. This often occurs around earnings as a stock may beat or miss expectations and will report on a pre-defined date. This anticipation of movement will increase the price of the option as a movement up or down is more likely to take place.
Information not provided by the Options Industry Council