Basic Options Concept

Option buyer has the right to buy or to sell the underlying asset but no obligation to do so.

Option seller (writer) has no right, but an obligation to complete the trade required by the option contract.

Call option: Gives its holder the right to purchase an asset at the strike price.
Put option: Gives its holder the right to sell an asset at the strike price.

American vs. European:
· American-style options can be exercised at any time up to the expiration date.
· European-style options can only be exercised on the expiration date.
· Since American-style gives more flexibility, it can be more expensive than European-style in some (but not all) cases.
· Both options have the same value on the expiration date.
· Most of the options throughout the world are A. options

Moneyness
The concept of moneyness describes whether an option is in-, out-, at-, or in-the-money by examining the position of strike vs. existing market price of the option's underlying security.

Call option is in-the-money if current asset price is greater than strike price, and out-of-themoney if current asset price is smaller than strike price.

Put option is in-the-money if current asset price is smaller than strike price, and out-of-the-money if current asset price is greater than strike price. If current asset price equals strike price, both are at the money

Over the Counter Options
Many derivative instruments such as forwards, swaps and most exotic derivatives are traded OTC.

· unregulated
· Dealers offer to take either a long or short position in option and then hedge that risk with transactions in other options derivatives.
· Buyer faces credit risk because there is no clearing house and no guarantee that the seller will perform
· Price, exercise price, time to expiration, identification of the underlying, settlement or delivery terms, size of contract, etc. are customized


Exchange-Traded Options
· traded on a regulated exchange
· All terms are standardized except price.
· The exchange establishes expiration date and expiration prices as well as minimum price quotation unit.
· The exchange also establishes whether the option is American or European, its contract size and whether settlement is in cash or in the underlying security.
· Usually trade in lots in which 100 shares of stock = 1 option
· The most active options are the ones that trade at the money
· Can be bought and sold with ease and holder decides whether or not to exercise. When options are in the money or at the money they are typically exercised.
· Most have to deliver the underlying security.
· Regulated at the federal level