Derivatives: introduction to options: contract size
An equity option is a financial contract between the issuer of the option and the ultimate holder of the option that gives the holder the right, but not the obligation, to buy or sell a stock or share at a given price per share (often referred to as the ‘strike’ price) on or before a given future specified date.
An option contract will outline and specify details agreed between the parties. This will typically include:
- whether the option holder has the right to buy or the right to sell;
- the description and quantity of the underlying asset;
- the strike price (see STSM112010), also known as exercise price (see STSM112050), which is the price at which the underlying transaction will take place upon exercise;
- the expiry date of the option (which is also the last date the option can be exercised;
- confirmation of settlement terms i.e. whether the issuer &/or holder of the option is obligated on exercise of the option to deliver/receive the actual asset, or simply arrange a cash settlement; and
- specify the premium (see STSM112020) that is to be paid by the option holder to the issuer of the option for the writing of the option contract.
The quantity of shares in an equity option is written and traded in terms of contract size, where one contract size option typically represents 1000 underlying shares. So, for example, a ‘two option’ contract to buy will represent a right to acquire 2000 shares (2 x 1000) in the underlying security.