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Option (finance)
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Option (finance)
In finance, an option is a contract which conveys to its owner, the holder, the right, but not the obligation, to buy or sell a specific quantity of an underlying asset or instrument at a specified strike price on or before a specified date, depending on the style of the option.
Options are typically acquired by purchase, as a form of compensation, or as part of a complex financial transaction. Thus, they are also a form of asset (or contingent liability) and have a valuation that may depend on a complex relationship between underlying asset price, time until expiration, market volatility, the risk-free rate of interest, and the strike price of the option.
Options may be traded between private parties in over-the-counter (OTC) transactions, or they may be exchange-traded in live, public markets in the form of standardized contracts.
An option is a contract that allows the holder the right to buy or sell an underlying asset or financial instrument at a specified strike price on or before a specified date, depending on the form of the option. Selling or exercising an option before expiry typically requires a buyer to pick the contract up at the agreed upon price. The strike price may be set by reference to the spot price (market price) of the underlying security or commodity on the day an option is issued, or it may be fixed at a discount or at a premium. The issuer has the corresponding obligation to fulfill the transaction (to sell or buy) if the holder "exercises" the option. An option that conveys to the holder the right to buy at a specified price is referred to as a call, while one that conveys the right to sell at a specified price is known as a put.
The issuer 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), or the buyer may pay a premium to the issuer 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. When an option is exercised, the cost to the option holder is the strike price of the asset acquired plus the premium, if any, paid to the issuer. If the option's expiration date passes without the option being exercised, the option expires, and the holder forfeits the premium paid to the issuer. In any case, the premium is income to the issuer, and normally a capital loss to the option holder.
An option holder 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. The market price of an American-style option normally closely follows that of the underlying stock being the difference between the market price of the stock and the strike price of the option. The actual market price of the option may vary depending on a number of factors, such as a significant option holder needing to sell the option due to the expiration date approaching and not having the financial resources to exercise the option, or a buyer in the market trying to amass a large option holding. The ownership of an option does not generally entitle the holder to any rights associated with the underlying asset, such as voting rights or any income from the underlying asset, such as a dividend.
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. On a certain occasion, it was predicted that the season's olive harvest would be larger than usual, and during the off-season, he acquired the right to use a number of olive presses the following spring. When spring came and the olive harvest was larger than expected, he exercised his options and then rented the presses out at a much higher price than he paid for his 'option'.
The 1688 book Confusion of Confusions describes the trading of "opsies" on the Amsterdam stock exchange (now Euronext), explaining that "there will be only limited risks to you, while the gain may surpass all your imaginings and hopes."
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Option (finance)
In finance, an option is a contract which conveys to its owner, the holder, the right, but not the obligation, to buy or sell a specific quantity of an underlying asset or instrument at a specified strike price on or before a specified date, depending on the style of the option.
Options are typically acquired by purchase, as a form of compensation, or as part of a complex financial transaction. Thus, they are also a form of asset (or contingent liability) and have a valuation that may depend on a complex relationship between underlying asset price, time until expiration, market volatility, the risk-free rate of interest, and the strike price of the option.
Options may be traded between private parties in over-the-counter (OTC) transactions, or they may be exchange-traded in live, public markets in the form of standardized contracts.
An option is a contract that allows the holder the right to buy or sell an underlying asset or financial instrument at a specified strike price on or before a specified date, depending on the form of the option. Selling or exercising an option before expiry typically requires a buyer to pick the contract up at the agreed upon price. The strike price may be set by reference to the spot price (market price) of the underlying security or commodity on the day an option is issued, or it may be fixed at a discount or at a premium. The issuer has the corresponding obligation to fulfill the transaction (to sell or buy) if the holder "exercises" the option. An option that conveys to the holder the right to buy at a specified price is referred to as a call, while one that conveys the right to sell at a specified price is known as a put.
The issuer 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), or the buyer may pay a premium to the issuer 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. When an option is exercised, the cost to the option holder is the strike price of the asset acquired plus the premium, if any, paid to the issuer. If the option's expiration date passes without the option being exercised, the option expires, and the holder forfeits the premium paid to the issuer. In any case, the premium is income to the issuer, and normally a capital loss to the option holder.
An option holder 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. The market price of an American-style option normally closely follows that of the underlying stock being the difference between the market price of the stock and the strike price of the option. The actual market price of the option may vary depending on a number of factors, such as a significant option holder needing to sell the option due to the expiration date approaching and not having the financial resources to exercise the option, or a buyer in the market trying to amass a large option holding. The ownership of an option does not generally entitle the holder to any rights associated with the underlying asset, such as voting rights or any income from the underlying asset, such as a dividend.
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. On a certain occasion, it was predicted that the season's olive harvest would be larger than usual, and during the off-season, he acquired the right to use a number of olive presses the following spring. When spring came and the olive harvest was larger than expected, he exercised his options and then rented the presses out at a much higher price than he paid for his 'option'.
The 1688 book Confusion of Confusions describes the trading of "opsies" on the Amsterdam stock exchange (now Euronext), explaining that "there will be only limited risks to you, while the gain may surpass all your imaginings and hopes."