Lesson 2 — Option Contracts

An option contract is defined by several key components. A trader cannot analyze an option correctly without understanding these components. Every option has an underlying asset, a strike price, an expiration date, a premium, a contract size, and specific rules for exercise and settlement.

The underlying asset is the market the option is based on. It may be a stock, index, futures contract, ETF, or another instrument. The strike price is the price level at which the option can be exercised. The expiration date is the final date after which the option no longer exists. Premium is the price paid by the buyer and received by the seller.

Contract size determines the exposure. In many traditional equity options, one contract may represent 100 shares, but different markets can have different specifications. This is why traders must always read contract details instead of assuming all options behave the same way.

Option style also matters. American-style options can generally be exercised before expiration, while European-style options are exercised only at expiration. This difference affects assignment risk and strategy management. Settlement rules matter too. Some options settle physically, while others settle in cash.

This lesson also introduces moneyness. An option can be in the money, at the money, or out of the money depending on the relationship between the underlying price and the strike price. Moneyness affects premium, probability, risk, and strategy selection.

For 4Invest, understanding contract structure is essential because options strategy is not only about direction. It is about obligations, time, settlement, exposure, and risk. A professional approach begins by reading the contract correctly.

Students should finish this lesson able to look at an option contract and explain what is being traded, what the important terms mean, and what risks are attached to the contract design.

1. List the key parts of an option contract.
2. Explain the difference between strike price and underlying price.
3. Research one real option contract and write its expiration, strike, premium, and underlying asset.
4. Explain the difference between American-style and European-style options.
5. Write why settlement rules matter.