What you will learn
- Read the underlying, multiplier and strike before calculating.
- Distinguish exercise style from settlement method.
Option
The two basic types are calls, which give the right to buy, and puts, which give the right to sell. A buyer's maximum loss is the premium paid, while the seller keeps the premium but must perform if the buyer exercises, so a seller's loss can be much larger.
Exchange-listed options are standardized by strike, expiry and contract multiplier, which is the number of units one contract covers. The quoted premium is per unit, so the cash cost is the premium times the multiplier times the number of contracts. Time to expiry, the underlying price and volatility all affect the premium.
Strike Price
Exchanges list a ladder of strikes at regular intervals around the market price. The strike sets moneyness: a call is in the money when the underlying is above the strike, a put when it is below, and both are at the money when the two are about equal; otherwise they are out of the money.
Strike choice trades cost against odds. In-the-money options cost more because they carry intrinsic value and move more like the underlying; out-of-the-money options are cheaper but need a bigger move and more often expire worthless. Strikes can be adjusted after corporate actions such as splits.
Expiration (Expiry)
Conventions differ by exchange and product. Contract specifications state the last trading day, the expiry date and time, the exercise style and whether settlement is in cash or by physical delivery. Some exchanges and brokers automatically exercise options that finish in the money, but thresholds and cut-off times vary.
Time to expiry affects the premium, which equals intrinsic value plus time value. Time value shrinks toward zero at expiry, and the decay is usually fastest for at-the-money options in the final weeks. Positions near expiry can face assignment, delivery or margin changes, so many traders close earlier.
Worked example: Intrinsic value is only one measure
Illustrative: a call has strike HK$50 and a fictional underlying price of HK$53. Its intrinsic value is HK$3 per unit. With a multiplier of 100, that is HK$300 per contract before premium and costs. Whether and when it can be exercised, and whether settlement uses cash or delivery, depend on the actual contract specification.
Check your understanding
A call expires with the underlying at HK$48 and strike HK$50. What is its expiration payoff before premium?
Show answer and explanation
max(48 − 50, 0) = 0 per unit. Zero payoff does not mean zero loss: the holder may have lost the entire premium and costs.