Unit 5: Introduction to Options
An
option is a contract that gives the buyer the right, but not the obligation, to
buy or sell an underlying asset at a specific price on or before a certain
date.
An
option, just like a stock or bond, is a security.
There
are two basic types of options – call options and put options.
There
are three main categories of options: European, American and Bermudan.
There
are four types of participants in options markets namely, Buyers of calls,
Sellers of calls, Buyers of puts and Sellers of puts.
The
Options Clearing Corporation is the sole issuer of all options listed at the
Chicago Board of Options Exchange (CBOE) and other U.S. options exchanges.
In
India, NSE has an associated clearing house attached to it for futures and
options trading.
Some
of the important terms used in option trading are: Option Class, Option price,
Strike Price, Expiration date and others.
There
are three positions in an option – In-the-money; At-the-money; and
Out-of-themoney.
The
option premium can be broken down into two components – intrinsic value and
time value.
Index
derivatives are derivative contracts which derive their value from an
underlying index.
The
two most popular index derivatives are index futures and index options.
Index
derivatives are a powerful tool for risk management for anyone who has
portfolios composed of positions in equity.
American
Options: American options are options that can be exercised at any time up to
the expiration date.
Most
exchange-traded options are American.
At-the-money
option: An at-the-money (ATM) option is an option that would lead to zero cash
flow if it were exercised immediately.
Call
option: A call option gives the holder the right but not the obligation to buy
an asset by a certain date for a certain price.
