Options Details, Cost, and Structure:
An option is a contract that gives the buyer (the option holder) the right but not the obligation to buy/sell the underlying asset at the agreed price at a future time. The option writers are the sellers of the option and are obligated to buy/sell the underlying asset to the option holder. When the option can be exercised by its buyers depend on whether it is an American or a European bond.
In general, American options can be exercised by their holders at any point of time in its life (before the expiration) while European options can only be exercised at the point of maturity. In this report, we focus on American options.
The basic two structures of options are call and put.
1. Call options gives the holder the right to buy an asset at a certain price within a specific period of time. A call stock option is similar to having a long position on a stock. Buyers of calls expect increases in the price of the stock before the option expires.
2. Put options give the holder the right to sell an asset at a certain price within a specific period of time. A put option very similar to having a short position on a stock. Buyers of puts expect decrease in the price of the stock will fall before the option expires.
There are 4 main positions that one may hold when it comes to options - Long a call, Short a call, Buy a put and Short a put.
The cost of an option involves the price of the contract itself and the brokerage commission to be paid. The strike price of an option refers to the share price at which the shares of stock will be bought or sold if the holder of the option decides to exercise it. Strike prices are usually listed in increments of 2.5, 5, or 10 points, depending on the market price of the underlying security. Often, only strike prices that are a few levels above and below the current market price are traded.
Exchange Traded Options VS over-the-counter options
Exchange-traded options, also known as "listed options", are traded in standardized contracts. Except under special circumstances, all stock option contracts are for 100 shares of the underlying stock. Having standardized contracts mean that accurate pricing models are often available. Standardized option contracts also results in more orderly, efficient, and liquid option markets. Exchange traded options are settled through a clearing house such as the Options Clearing Corporation (OCC) so as to reduce the risk of market failure of the participant.
Different types of Exchange-traded options include:
• Stock options,
• Bond options and other interest rate options
• Stock market index options or, simply, index options and
• Options on futures contracts
• Callable bull/bear contract
Over-the-counter options, also called "dealer options", are traded between two private parties, and are not listed on any exchange. The terms of an OTC option are unrestricted and can be individually customized to meet any business need. In general, at...