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Introduction to Options
- An Option is a contract in which the seller (also called the writer) gives the buyer the right but not obligation to purchase from or sell to the seller a designated asset at a specific price which is agreed upon at the time of entering into the contract.
- Options are traded either on an organized exchange or on Over-The-Counter (OTC) market.
- A call option gives the buyer of an option the right to purchase from the seller the underlying asset and a 'put option,' gives the buyer of the option the right to sell the underlying asset.
- Moneyness of an option refers to the profit /loss made from an immediate exercise of an option.
- The over-the-counter options are customized contracts that are structured to suit the requirements of companies.
- Intrinsic value of an option is the value of the profits that are likely from the option.
- The difference between the option premium and the intrinsic value is defined as time value.
- Options exist on a variety of underlying instruments ranging from stock, indices to foreign currencies and commodities. For example, options on individual stocks are known as equity options and are the most actively traded options on any exchange.
- Options on bonds are mostly found on treasury bonds and are actively traded than any other bonds on an exchange.
- An interest rate cap and floor are special types of borrowings and lending options.
- A collar is a combination of a cap and a floor where we can sell a floor at a lower strike rate and buy a cap at a higher strike rate.
- An option on a currency basket is an option whose value is based on the value of a basket comprising multiple currencies.
- Options that are traded on an exchange are known as exchange traded options,
- A person or a firm that quotes a bid price as well as ask price in a financial instrument or commodity, with an intention to gain profits through bid/ask spread is known as market maker.