All of the options ► Option contracts
Option contracts. General characteristics
Under options understands special kind of stock exchange transactions with a limited, compared with the usual operations of futures risk. The options are conditional forward transactions, providing one of the contracting parties the right to execute or not to execute the contracts, in contrast to the solid deals (forwards and futures), are binding. In recent years, the options are gradually gaining increasing popularity as a more complex, but at the same time providing significantly greater opportunities compared with futures, financial instruments.
Option indicates emergency deal whereby one party acquires the right to accept or transfer of an asset at a fixed price within a certain period, and the other party shall, at the request of the counterparty for the cash prize to ensure the implementation of this law, imposing the obligation to send or receive a subject of the transaction at a fixed price. Thus, a feature of the option is that in the transaction of sale, where it acts as an object, the buyer acquires no title of property and the right to acquire it.
Obligations of the buyer of the option limited to the timely payment of the option premium to the option seller. In turn, the seller must provide certain guarantees strictly fulfill its obligations in the form of cash collateral (margin) or securities. The difference in the nature of the obligations assumed by the buyer and the seller of an option reflects the division of the potential risks, profits and losses between the parties.
For the buyer of the option the possible losses are limited to the size of the premium paid, ie risk by purchasing options is limited, and the profit potential is unlimited. The seller of the option is always the risk of unlimited losses, while its maximum profit is limited to the size of the award.
Options exist in two forms, contracts for the purchase and sale contracts.
1. an option to purchase (options "call"), under the terms of which the option holder has the right to buy an asset at a specified price (the strike price of the) from a person who has issued the contract. In turn, the option seller is obligated to sell the asset if the option holder so requires.
2. The option to sell (options "put"), under the terms of which the option holder has the right to sell an asset at a specified price person drawn the option. In turn, the seller of the option is obliged to buy the asset if the option holder makes a contract for settlement/
Writing out the option, the seller in this transaction opens a short position and the buyer - a long position. Accordingly, the concept of a short "call" or "put" means the sale of the option "Call" or "Put" and a long "call" or "put" - their purchase.
The price of the option - premium, ie amount paid for buying the option. It consists of two components - the intrinsic value and time value. Intrinsic value - the difference between the current price of the underlying asset (the spot price) and strike price (price-strike).
Time value - the difference between the sum of the premium and the intrinsic value. If there is a lot of time, the time value can be significant value to the expiry of the contract.
As we approach this period, it decreases and on the day of expiration of the contract will be zero.
Premiums on options vary depending on market conditions.
They depend on various factors, the most significant of which is the time before the execution (the end of the period of validity) and market volatility. The theoretical value of the option can be calculated based on different pricing models and on the basis of a variety of known factors, such as historical (statistical) price fluctuations, until the end of the period of validity, the spot price, interest rates, etc .; however, the market price may be quite different, because it takes into account the expected price fluctuations (expected volatility), as well as the supply and demand ratio.
The bidding process is generated such value of the option that suits both parties to the transaction and calls their chances of making a profit.
The options are divided into types depending on the relationship between income and the chances of risk:
- Internal ( "money") options have a strike price, below the current market price of the underlying asset for the "call" and above the market price for the "put". Formally, this means that the buyer of these options can immediately take advantage of their right to receive the net income after the sale (purchase) of an asset. The appearance of such arbitrage prevents that the premium on the internal option always overrides the variance in the amount depending on the demand, supply and expectations of growth of the price of the asset. Value Mezhuyev chances of income and risk is characterized as a "big board - low risk";
- External ( "out of the money") options have a strike price, much higher than the spot price of the asset for the "call" and significantly lower for the "put". Award for External options is very low, since the performance of these options require that you change the price-spot by a significant amount in the right direction, as this event often has a low probability. This type of option characterizes the statement "low cost and great risk";
- Market ( "at the money", "in the money") options have a strike price, which is close or equal to the market price of the underlying asset, and accordingly "medium risk and cost."
In terms of deadlines options are divided into two types:
American and European. American option can be exercised on any day up to the expiration of the contract, and European - only on the day of expiry of the contract.
Just as in the case of futures contracts, there is a primary and secondary options markets. Primary options market operates almost continuously: speculators and other investors are discharged options, the terms of which reflect the constantly changing assessment of the current market situation and future trends. In this sense, the operation of the primary options market depends on the movement in the spot market. Holders of options can, in turn, sell them to a third party, so there is a secondary options market, where they are treated similarly to other derivatives, ie, over the counter market and on exchanges.
On the open market option contract inextricably binds the buyer and seller. any additional conditions in order to achieve a compromise between the buyer and seller can be included in the contract. For example, the right to extend the option. In the OTC market no restrictions on the type of underlying asset, other than that permitted any size option contract.
The options, which are traded on the stock exchange, called "quoted options." Exchange trade options structured to allow them multiple resale. Terms of options traded on the stock market, are standard, so that they are highly liquid.
Ceteris paribus the price (prize) resale is reduced as you get closer to the life of the option expiration date.
Exchange trade options on futures organized by type. Its distinguishing feature - the parties are not in the same position in terms of contractual obligations. Therefore, the buyer of the option pays a premium only when opening a position. The option seller is obliged to pay an initial margin. If you change the current course of the underlying asset margin size can be changed to provide a guarantee of the strike by the seller. In the exercise of the option chooses a clearinghouse face the opposite position, and instructs him to carry out the action in accordance with the contract. Closing the option position is carried out by:
- Fulfill the conditions of the option in accordance with established procedure, called the exercise of the option;
- By entering into a reverse option - foreclosure, if the option was sold, and the sale, if the option was purchased.
Option offers a number of features not available to other products, especially in structuring and hedging positions. They can be used to increase and to reduce the risks.
Option transactions may be caused by the client's interest in the underlying assets, and the desire to use options directly as objects of investment activity. The attractiveness of options for investors is not only limited risk of long positions.
Options provide great opportunities for speculative trading. Combinations of purchase and (or) sale of call and put options in conjunction with the purchase and (or) sale of real assets allow us to find revenue-generating strategies for virtually any market situation.
Moreover, there are option strategies that do not require even predict the market rate of the underlying asset for a profit.
When purchasing options available large variety of contracts with different expiration dates and strike-prices, which are the building blocks in the formation of option strategies. However, we must remember that in the options trading commission costs can reach considerable size - sometimes to cover operating expenses goes to half the profits. Theoretically, there are situations where the potential profit from the deal looks very attractive in comparison with the expected risk. However, given the Commission the result of such operations can be a net loss.
Variety of options contracts
An asset that is the basis of the option does not have to be a real physical item (currency, securities), permitting the supply. As in the case of futures contracts, options on common interest rates or currency exchange rates. In this case, instead of delivering the goods made the calculation and payment of profit-loss in monetary terms. In addition to these kinds of options that have become classics, there are a number of more complex options, some of which are "exotic".
Options on futures contracts - options that give the right to buy or sell a futures contract on an asset. If in the case of options and futures transactions settled by the delivery of the assets to which they are written, in the case of an option on futures transaction is settled by delivery of an asset is not, and by the delivery of futures contracts on the asset.
Options on stock indexes - settlement options in the implementation of which the seller of the option holder pays the difference between the option exercise price specified in the contract, and a calculated value associated with the actual index value. The attractiveness of stock exchange indices for investors is that they avoid the risks associated with the deterioration of the financial position or performance of any of any particular company. In fact, operations with stock indices give investors the opportunity to "play" on the industry or on the stock market as a whole. The game is based on the fact that the value of the stock index changes over time for several reasons: it can change the composition of indeksa1 and besides, he index figure changes daily with the movement of share prices, which are included in it as a component. Options on indices are used for speculative purposes, for hedging and for investment funds, rather than purchase their own securities.
Options on futures contracts on stock indices are written not on the index itself, and on the futures contract. Thus, if an investor is the holder of the call option and sells a call option, it pays a person to write out this option, the difference between the option exercise price and the current price of a futures contract on a stock index. Accordingly, the sale of the option holder receives such a difference from the person who has drawn an option.
Options on options - combined options or options on options provide the buyer the right, but not the obligation to buy the underlying ordinary (basic) option at a later date.
This will allow the buyer to minimize the initial premium, which he has to pay, determined to buy the underlying option. Instead of the full payment of the underlying option buyer buys an option for him. If at the time of execution of the last basic option of no interest to the buyer, the buyer can refuse to purchase it and avoid further expenses. Otherwise, the buyer can fulfill your combo option, buying the base option at a predetermined price.
In recent years began to appear more flexible financial instruments than simple options.
Expiry time the time determines the expiry of the binary option. Simply put, this means how long you expect the outcome rates after installation order (the end of the transaction)…