Option Terminology

An option is exercised when the person converts the option into a long or short future position. For example, if Robert exercised his option he would become long the future at 100. If Susan exercised her option she would become short the future at 100.

An option may be assigned to a person who is short a call or put. When someone exercises an option another person automatically gets assigned. For example, if Robert exercises his call and becomes long the future, someone else who is short the call must get assigned and now become short the future. If Susan exercises her put, she will become short the future, and someone else who is short the put will get assigned and become long the future. The number of long positions must always balance the number of short positions.

An option may be in the money, at the money, or out of the money, depending on the strike price, the future price, and whether the option is a call or put. 

1. In the money option: A call is in the money if the underlying future is trading above the strike price. A put is in the money if the underlying future is trading below the strike price. Susan's put is in the money because the future is below the strike price.

2. At or near the money option: A call or put is at the money if the underlying future is trading close to the strike price of the option. If the future trades at 100, both Robert's and Susan's options will be at the money.

3. Out of the money option: A call is out of the money when the future is trading below the strike price. A put is out of the money when the future is trading above the strike price. Robert's call is out of the money because the strike price is above where the future is trading.

Three kinds of options and how they relate to the price of the security. Assume the market is currently trading in the 100 range. A call or a put with a 100 strike would be considered an at the money option because the future is trading at the strike price.

Calls above the 100 level would be considered out of the money options because the future is trading below the level where the calls may be exercised. Exercising the calls would make the owner long the market above the level it is currently trading an unwise and unprofitable situation. Puts above the 100 level would be considered in the money options because the owner of the puts could exercise or sell the future above the level the market is currently trading.

Calls below the 100 level would be considered in the money options because the owner could exercise or buy the future below the level the market is currently trading. Puts below the 100 level would be called out of the money options because the future is trading above where the put may be exercised. Exercising the put would make the owner short the market, below the level it is currently trading-another unwise and unprofitable situation.