Booyah Breakdown: Options Expiration

Editor's note: Welcome to "Booyah Breakdown," an explanation of certain terms and topics Jim Cramer discusses on his "Mad Money" TV show. Feel free to ask a question if you're confused about something Cramer talks about, but please keep in mind that we do not provide advice on specific stocks.

So many things work in tandem. Take your favorite car. All the different parts need to be working properly to ensure that smooth ride. Recognizing the relationship of those parts can help prevent those horrific roadside breakdowns.

Same goes for the options, equity and futures markets. They all work together, so to understand one, you need to understand the others. We tackle the equity market all the time, and last week we hit on the futures market. So it's high time we dove into the options world and started to put the pieces together.

We'll save the technicalities of trading on the options market for another day. Today we're going to focus on what you can learn just by watching the options market and its monthly revelry, a.k.a. "options expiration week."

Options expiration week can set off a chain of events, including an increase in volume and volatility in the stock market. Jim Cramer refers to it often. For instance, he wrote in his RealMoney blog on Aug. 23 that the previous week's rally was "no doubt ... exacerbated by options expiration."

How could options expiration affect a rally? Read on.

Optional Insurance

Let's first understand how options work before we dive into what happens when they expire.

An option is a type of insurance. It's a contract that gives you the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.