Jump to navigation Jump to search “Stock option” redirects here. For the power option binary broker incentive, see Employee stock option. The seller may grant an option to a buyer as part of another transaction, such as a share issue or as part of an employee incentive scheme, otherwise a buyer would pay a premium to the seller for the option.
A call option would normally be exercised only when the strike price is below the market value of the underlying asset, while a put option would normally be exercised only when the strike price is above the market value. The owner of an option may on-sell the option to a third party in a secondary market, in either an over-the-counter transaction or on an options exchange, depending on the option. Contracts similar to options have been used since ancient times. The first reputed option buyer was the ancient Greek mathematician and philosopher Thales of Miletus. 1690s during the reign of William and Mary. Film or theatrical producers often buy the right — but not the obligation — to dramatize a specific book or script. Lines of credit give the potential borrower the right — but not the obligation — to borrow within a specified time period.
Many choices, or embedded options, have traditionally been included in bond contracts. Options contracts have been known for decades. The Chicago Board Options Exchange was established in 1973, which set up a regime using standardized forms and terms and trade through a guaranteed clearing house. Trading activity and academic interest has increased since then.
Today, many options are created in a standardized form and traded through clearing houses on regulated options exchanges, while other over-the-counter options are written as bilateral, customized contracts between a single buyer and seller, one or both of which may be a dealer or market-maker. A financial option is a contract between two counterparties with the terms of the option specified in a term sheet. The terms of an OTC option are unrestricted and may be individually tailored to meet any business need. By avoiding an exchange, users of OTC options can narrowly tailor the terms of the option contract to suit individual business requirements. In addition, OTC option transactions generally do not need to be advertised to the market and face little or no regulatory requirements.
However, OTC counterparties must establish credit lines with each other, and conform to each other’s clearing and settlement procedures. With few exceptions, there are no secondary markets for employee stock options. These must either be exercised by the original grantee or allowed to expire. The most common way to trade options is via standardized options contracts that are listed by various futures and options exchanges. Listings and prices are tracked and can be looked up by ticker symbol. Maintenance of orderly markets, especially during fast trading conditions.
These trades are described from the point of view of a speculator. If they are combined with other positions, they can also be used in hedging. An option contract in US markets usually represents 100 shares of the underlying security. The cash outlay on the option is the premium. The trader would have no obligation to buy the stock, but only has the right to do so at or before the expiration date. The holder of an American-style call option can sell his option holding at any time until the expiration date, and would consider doing so when the stock’s spot price is above the exercise price, especially if he expects the price of the option to drop. By selling the option early in that situation, the trader can realise an immediate profit.
Alternatively, he can exercise the option — for example, if there is no secondary market for the options — and then sell the stock, realising a profit. The trader will be under no obligation to sell the stock, but only has the right to do so at or before the expiration date. If the stock price at expiration is below the exercise price by more than the premium paid, he will make a profit. It is important to note that one who exercises a put option, does not necessarily need to own the underlying asset. Specifically, one does not need to own the underlying stock in order to sell it.
The reason for this is that one can short sell that underlying stock. A trader who expects a stock’s price to decrease can sell the stock short or instead sell, or “write”, a call. If the seller does not own the stock when the option is exercised, he is obligated to purchase the stock from the market at the then market price. A trader who expects a stock’s price to increase can buy the stock or instead sell, or “write”, a put. Payoffs from buying a butterfly spread. Simple strategies usually combine only a few trades, while more complicated strategies can combine several.
Strategies are often used to engineer a particular risk profile to movements in the underlying security. X2, and does not expose the trader to a large loss. Similar to the straddle is the strangle which is also constructed by a call and a put, but whose strikes are different, reducing the net debit of the trade, but also reducing the risk of loss in the trade. If the stock price rises above the exercise price, the call will be exercised and the trader will get a fixed profit. If the stock price falls, the call will not be exercised, and any loss incurred to the trader will be partially offset by the premium received from selling the call. This strategy acts as an insurance when investing on the underlying stock, hedging the investor’s potential loses, but also shrinking an otherwise larger profit, if just purchasing the stock without the put. Options can be classified in a few ways.