Options are the right to exercise a contract or undertake a business activity. Financial options (as well as their underlying assets) are usually traded on exchanges. Real options involve assets or business opportunities often unique to a business, and decisions to undertake these types of projects are normally considered to be capital budgeting decisions (see Real Options Valuation).
Here we look at financial options that are traded in financial markets. These options are very much like futures; however, future contracts require both parties to hold up their end of the deal - options do not. Options give one party the right, but not the obligation, to buy or sell a given quantity of an asset ("underlying asset") on (or perhaps before) a given date, at a price agree upon today.
Call Option: A call option gives the holder of the option the right, but not the obligation,to buy a given quantity of some asset at some time in the future, at a price agreed upon today.
Put Option: A put option gives the holder the right, but not the obligation, to sell a given quantity of an asset at some time in the future, at a price agreed upon today.
Styles of Options
European Options: European options are options that can be exercised only at the expiry date.
American Options: American-style options are options that can be exercised up until and including the expiry date.
Asian Options: Asian options, or average value options, are a more complex option where the payoff is determined by the average price of the underlying asset over a set period of time.
LEAPS: Long-term equity anticipation securities are options with an expiration date usually over one year.
Exercising the Option: Performing the contract by using the option to buy or sell the underlying asset.
Strike Price or Exercise Price: The specified price written in the option contract that is agreed upon before at which the holder can buy or sell the underlying asset.
Expiry Date: Self explanatory. This is the maturity date of the option. Some options can only be exercised at the expiry date, some can be exercised any time up until the expiry date.
In-the-money: If the exercise price is less than the market price of the underlying asset, a call option is considered to be "in-the-money" (and vica versa for a put option).
At-the-money: If the exercise price is equal to the market price of the underlying asset, both a call and put option are considered "at-the-money."
Out-of-the-money: If the exercise price is more than the market price of the underlying asset, a call option is considered "out-of-the-money" (and vica versa for a put option).© BrainMass Inc. brainmass.com August 12, 2022, 8:24 pm ad1c9bdddf