Options Hedge Against Risks Or For Speculation

2530 words - 10 pages

A Finance II Home AssignmentOptionsHedge against risks or for speculationTable of contentsOptions through history 3Lang Call 3Short Call 3Long Put 4Short Put 4Option Strategies 5Covered Call 5Small Cap 5Collar 6Straddle 6Strangle 6Trading 8Reference: 9Options through historyTaking look through history we can see that there were very similar types of contracts used since ancient time. Even there are written proves about options purchases , for instance Aristotle had written about buying options in order to use olive presses during the coming harvest. Options have been used by real estate developers. Options as we know them today began trading at the Chicago Board of Trade (CBOT) in 1982 as financial futures. When Chicago Board of Trade was established in 1982, few observers guessed what kind of success it would be. Since then, trading volume in these contracts has grown dramatically- placing them consistently on the lists of the most actively traded contracts in the world. They have become indispensable tools for risk management and speculative trading. Nowadays CEBOT trades options to buy or sell more than 30 billion shares of stock in 1 500 companies each year.Call option is right to buy an asset at specified exercise price on or before the exercise date.Put option is the right to set an asset at specified exercise price on or before the exercise dateThe buyer of the option has the right but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying instrument) from the seller of the option at a certain time for a certain price (the strike price). There are the four basic option trades:Long callShort CallLong PutShort PutLong call (Long Position)An investor, person who is buying of a security such as a stock, commodity or currency think that for instance particular stock price will increase. Investor has option to purchase stock and wait until the price increase or to buy the right to purchase stock (call option). In case that he is going to buy call option on certain stocks he is not obliged to buy them and become their owner, he has the right to do so until the moment option will expire (expiry date). If the stock price increases over the exercise price by more than the premium paid, he will profit. If the stock price decreases, he will let the call contract expire worthless, and only lose the amount of the premium.Short call (Naked Short Call)Short call is opposite of Long Call. As trader, person who is selling of a borrowed or owned security, commodity or currency, his expectation are that the asset will fall in value. He believes that a particular stock's price will decrease. He can sell the stock or sell a call which he posses. The trader selling a call has an obligation to sell the stock to the callbuyer at the buyer's option. In case that the stock price will decrease, the short call option is going to make a profit in the amount of the premium (value of the call). If the stock...

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