A stock option is a legally binding agreement that guarantees a person the opportunity to buy or sell shares of a stock at a pre-agreed price by a specific date. Generally, these options are extended to employees by employers. Like most stocks, any stock purchased as part of a stock option can also be sold on the date of purchase.
Generally speaking, you can buy and sell stock options as often as you would like. If your trade activity exceeds a certain amount per day, however, the SEC may require you to maintain a certain amount of funding in your account.
Types of Options
Stock options come in two varieties. The first type, known as a call, gives a person the right to purchase a stock. Every aspect of the stock purchase is dictated by the option, including the number of shares that may be purchased and the price per share. The flip side of the call is the put stock option. The put, which also dictates the number and price per share, gives a person the right to sell stock.
Stock Agreement Due
The date that a stock option comes due is the absolute final date on which the shares of the stock may be purchased or sold for the specified price. After that date, the stock option becomes void. If the owner of the stock option wishes to purchase or sell stock after this date, he must buy or sell the stock at its current price.
Why Stock Options?
Stock options have several advantages over the automatic issuing of stock to an individual. If you have the right to buy a stock by a specific date, you can also make the choice not to take the stock. Because any stock given to you by your company must be declared as taxable income, a stock option lets you avoid that tax burden. Stock options also allow you to follow the stock's gains and losses to determine whether it is likely to gain in value.
Same Day Sale
Because a stock option includes a guaranteed price per stock, known as the exercise price, the market fluctuations of the stock price have no effect on the purchase price for the option holder. If the stock option exercise price is $20 per share, for example, but the market value of the stock is $100 per share on a date when the option is still valid, the option holder may buy the offered shares of stock at $20 per share and sell the stock the same day for $100 per share, turning a tidy one-day profit. Any income made from the stock sale must be declared as income for tax purposes.
Pattern Day Trader Rule
Note that if you repeatedly buy and sell shares of the same stock on the same day using a brokerage account that supports margin trading, generally four or more such trades within five business days, you may be required to keep at least $25,000 in your account under a Securities and Exchange Commission rule called the pattern day trader rule. Some brokerages may have stricter rules about who is classified as a pattern day trader, so if you don't want to keep that sort of balance you should make sure you understand the federal rules and your broker's policies.
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- Cboe. "What Happens to My Long Option if I Never Sell or Exercise It?" Accessed June 23, 2020.
- Corporate Finance Institute. "Strike Price." Accessed June 23, 2020.
- Fidelity. "What You Need to Know About Cash-Covered Puts." Accessed June 23, 2020.
- Fidelity. "Selecting a Strike Price and Expiration Date." Accessed June 23, 2020.
Alexis Lawrence is a freelance writer, filmmaker and photographer with extensive experience in digital video, book publishing and graphic design. An avid traveler, Lawrence has visited at least 10 cities on each inhabitable continent. She has attended several universities and holds a Bachelor of Science in English.