Options Terminology

For any given asset at any given time, many different option contracts may be trading. Suppose there are four expiration dates and five strike prices for options on a particular stock. If call and put options trade with every expiration date and every strike price, there are a total of 40 different contracts. All options of the same type (calls or puts) on a stock are referred to as an option class. For example, IBM calls are one class, whereas IBM puts are another class. An option series consists of all the options of a given class with the same expiration date and strike price. In other words, it refers to a particular contract that is traded. For example, IBM 200 October 2014 calls would constitute an option series.

Options are referred to as in the money, at the money, or out of the money. If S is the stock price and K is the strike price, a call option is in the money when S > K, at the money when S = K, and out of the money when S < K. A put option is in the money when S < K, at the money when S = K, and out of the money when S > K. Clearly, an
option will be exercised only when it is in the money. In the absence of transaction costs, an in-the-money option will always be exercised on the expiration date if it has not been exercised previously.

The intrinsic value of an option is defined as the value it would have if there were no time to maturity, so that the exercise decision had to be made immediately. For a call
option, the intrinsic value is therefore max(S - K; 0). For a put option, it is max(K – S; 0). An in-the-money American option must be worth at least as much as its intrinsic value because the holder has the right to exercise it immediately. Often it is optimal for the holder of an in-the-money American option to wait rather than exercise immediately. The option is then said to have time value. The total value of an option can be thought of as the sum of its intrinsic value and its time value.