Series 7 Study Textbook

How To Understand Options On The Series 7 Exam
to become a General Securities Registered Representative

One of the keys to passing the Series 7 exam is to make sure that you have a complete understanding of how options will be tested on the Series 7 Exam. This article which was produced from material contained in our Series 7 textbook and will help you master the material so that you pass the Series 7 exam.


What is an Option?

An option is a contract between two parties that determines the time and price at which a stock may be bought or sold. The two parties to the contract are the buyer and the seller. The buyer of the option pays money, known as the option's premium, to the seller. For this premium, the buyer obtains a right to buy or sell the stock depending on what type of option is involved in the transaction. The seller, because they received the premium from the buyer, now has an obligation to perform under that contract. Depending on the option involved, the seller may have an obligation to buy or sell the stock. Series 7 candidates can expect to see 40 to 45 questions on options. Approximately 30 to 35 questions will be on equity options and up to 10 questions will be on non-equity options. We will begin with equity options.

Option Classification

Options are classified as to their type, class, and series. There are two types of options: calls and puts.

Call Options

A call option gives the buyer the right to buy or to "call" the stock from the option seller at a specific price for a certain period of time. The sale of a call option obligates the seller to deliver or sell that stock to the buyer at that specific price for a certain period of time.

Put Options

A put option gives the buyer the right to sell or to "put" the stock to the seller at a specific price for a certain period of time. The sale of a put option obligates the seller to buy the stock from the buyer at that specific price for a certain period of time.

Option Classes

An option class consists of all options of the same type for the same underlying stock.

For example all XYZ calls would be one class of options and all XYZ puts would be another class of option.

Class 1 Class 2
XYZ June 50 Calls XYZ June 50 Puts
XYZ June 55 Calls XYZ June 55 Puts
XYZ July 50 Calls XYZ July 50 Puts
XYZ July 55 Calls XYZ July 55 Puts
XYZ August 50 Calls XYZ August 50 Puts

Option Series

An option series is the most specific classification of options and consists of only options of the same class with the same exercise price and expiration month. For example, all XYZ June 50 calls would be one series of options and all XYZ June 55 calls would be another series of options.

Bullish vs. Bearish

Bullish

Investors who believe that a stock price will increase over time are said to be bullish. Investors who buy calls are bullish on the underlying stock. That is, they believe that the stock price will rise and have paid for the right to purchase the stock at a specific price known as the exercise price or strike price. An investor who has sold puts is also considered to be bullish on the stock. The seller of a put has an obligation to buy the stock and, therefore, believes that the stock price will rise.

Bearish

Investors who believe that a stock price will decline are said to be bearish. The seller of a call has an obligation to sell the stock to the purchaser at a specified price and believes that the stock price will fall and is therefore bearish. The buyer of a put wants the price to drop so that they may sell the stock at a higher price to the seller of the put contract. They are also considered to be bearish on the stock.

  Calls Puts
Buyers Bullish
Have right to buy stock,
want stock price to rise
Bearish
Have right to sell stock,
want stock price to fall
Sellers Bearish
Have obligation to sell
 stock;
want stock  price to fall
Bullish
Have obligation to buy stock;
want stock price to rise

Buyer vs. Seller

Buyer   Seller
     
Owner Known as Writer
Long Known as Short
Rights Has Obligations
Maximum Objective Premium
Speculative   Income
ProfitWith an
 Opening   purchase
  Enters the contract Wants the option   With an
Opening sale

 

To  
Exercise   Expire