Option Investor
Educational Article

That's Classy

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What's an option's class? What's the difference in a striking price and an exercise price? Why are options not offered for all months on all underlyings?

The answers to these important questions and many more can be found in several sources. Those include Chapter 1 of Lawrence G. McMillan's Options as a Strategic Investment; a 20-minute online tutorial, the CBOE's "Options Overview,", and other sources. Many experienced options traders will already be familiar with all the information offered there. Further information such as the various cycles for different underlyings can be found in those sources as well as in Matt Kearney's online webinar on "Equity Options Expiration" found on the educational site for the Option Industry Council (OIC). Kearney is with the Chicago Board Options Exchange, the CBOE. For those who do not want to read further in this article on some of the basics of options, I urge that you at least investigate the link to the educational courses offered by the Option Industry Council as well as those offered by the CBOE. That's why they were listed at the first of the article rather than as a suggestion for further study at the conclusion of the article.

Even though this information is available in the several sources I listed in the previous paragraph, a brief review might be appropriate in this Option 101 space. All the puts and calls on the same underlying are in the same class. For example, all the puts and calls for IBM comprise a class of options. All the puts and calls for the SPX make up another class. A JAN MNX 115 put is in the same class of options as a MAR MNX 109 call.

As most reading this article will already understand, the numbers in those examples came from the strike, striking price, or exercise price of the option. The answer to the question asked in the first paragraph, the difference in a striking price and an exercise price, is that there is no difference. They're different terms for the same thing.

The CBOE's "Options Overview" defines the term variously known as the "strike," "striking price," or "exercise price" as "the price at which the underlying security . . . can be bought or sold as specified in the option contract." In other words, if you've bought a JAN CSCO 17.50 call, that call gives you the right but not the obligation to buy CSCO at $17.50. The strike, striking price or exercise price of your option is $17.50. As of the close on December 5, you would have paid about $76 ($0.76 x 100 multiplier) for that right but not obligation to buy 100 shares of CSCO at $17.50.

If CSCO were to climb to $19.50 early in January, your option would be in the money by $2.00 ($19.50 stock price - $17.50 strike). If you wanted to acquire the stock, you would have the right to exercise your option and acquire 100 shares of CSCO at $17.50. You would add the $76.00 (plus commissions) that you paid for the option to your basis for the purchase, but if you were interested in owning CSCO and it was $19.50, you'd probably be happy that you had been able to buy it so cheaply. You of course would also have the right to acquire the stock at $17.50 if CSCO were trading at $15.50, too, but that wouldn't make much sense to exercise the option in that case. The option would be $2.00 out of the money in that case, and no benefit would be had by exercising it.

Some traders, new and experienced, will have noticed that not all classes of options have options available for all months or expiration periods. For example, as of December 5, IBM options were available for December and January, but not for February or March. April and July options were available. What's up with that, with the skipped months?

As Matt Kearney explains in his webinar, underlyings have options with expiration dates in one of three possible fixed cycles. The cycles are set when the options are first offered on the underlying. McMillan (5) lists the three cycles as follows:

January/April/July/October cycle
February/May/August/November cycle
March/June/September/December cycle

Both Kearney and McMillan point out that in addition to the options that pertain to the assigned cycle, options are also offered in the nearest two months. From the months listed for IBM, for example, we can see that it's on the January/April/July/December cycle. However, although December is not part of that cycle, December options are offered in IBM as of December 5, because that's one of the nearest two months. After the expiration of December options, February options will be available although February is also not part of IBM's January/April/July/December cycle.

A study of GE's available options would show that GE's options belong to the March/June/September/December cycle, since both March and June options were available as of December 5. However, even though September is part of that cycle, no September 2009 options were yet available. McMillan notes that "the longest-term expiration dates are normally no farther away than 9 months" (5). Some underlyings do have longer-term options, called LEAPS.

Both Kearney and McMillan explain the schedule for new LEAPS. The schedule depends on the cycle in which options are offered on a particular underlying. Not all underlyings have LEAPS, however.

If you're new to options, check out the CBOE's online tutorial. Those new to options as well as more experienced traders who would perhaps like a review might find Kearney's webinar valuable, and McMillan's book is a must-have for options traders.

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