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What is Option
Option is a term which refers to the right of its holder to buy or sell the underlying asset.

Option is a term which refers to the right of its holder to buy or sell the underlying asset. For options they are mostly shares, stock indices, debt instruments, foreign currencies, commodities, or even derivatives (Futures, swaps).

Attention, option for the buyer indicates the right but not the obligation - if it is disadvantageous for the owner of the option, he does not apply it. Conversely, the seller (subscriber) of the option has the obligation to buy or sell an option under specified conditions.

Basic types of options:

  • call option (purchase) - gives its holder the right to a future date, to buy the underlying assetat a predetermined price, while it gives the issuer the obligation to sell
    • naked call - seller does not own the underlying asset (e.g. share) at the time of the option sale, he hopes that the option will not be used or that he acquires the underlying asset at the option claim
    • covered call - seller already own the underlying asset (e.g. share) at the time of the option sale
  • put option (sale) - gives its holder the right to a future date, to sell the underlying asset at a predetermined price, while it gives the issuer the obligation to buy

The predefined price is called strike price or exercise price.

Option due date is called expiration date or maturity.

Call and put options may be:

  • American type / American option - can be applied at any time during the period of maturity, sold or purchased may be at any time during its life (up to expiration date)
  • European type / European option - can only be applied at the time of maturity, sold or purchased may be at any time during its life (up to expiration date)

Both types are traded both in Europe and in the USA.

Options are further distinguished into:

  • Long Position - it is the buyer’s position
  • Short Position - it is the position of the seller / organiser / subscriber / writer / issuer

The seller (subscriber) sells call or put option to the buyer and collects the price of the option (option premium).

Option is one of the securities. It is in the category of derivatives. Options were traded on the stock exchanges and OTC (over the counter) since 1973.

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Last update: 16.05.2016

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