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Chapter 27
OPTIONS MARKETS
Options Contracts
The right, not the obligation, to either buy or sell a specified amount of a specific asset at a specified price within a specified period of time.
Options Terminology
Option price or option premiumExercise price or strike priceExpiration date or maturity dateCall option or put optionAmerican option or European optionMaximum profit or maximum lossExchange-traded options or over-the-
counter options
Differences Between Options and Futures Contracts
Both parties to a futures contract accept an obligation to transact, while only the options writer has such an obligation.
The option buyer has a limited, known maximum loss.
The risk/return profile of an option position is asymmetric, while that of a futures position is symmetric.
Risk/Return Characteristics of Call Options
The purchase of a call is like taking a long position in the underlying asset with a fixed, maximum loss. Benefits the buyer if the price of the
underlying asset rises. Benefits the seller if the price of the
underlying asses falls or is unchanged.
Risk/Return Characteristics of Put Options
The purchase of a put is like taking a short position in the underlying asset with a known maximum loss. Benefits the buyer if the price of the
underlying asset falls. Benefits the seller if the price of the
underlying asset rises or is unchanged.
Economic Role of the Options Market
Hedging With Futures Minimizes the risks of adverse price
movements. Gives up the benefits of favorable price
movements.Hedging With Options
Limits price risk. May benefit from favorable price
movements. May mold a risk/return relationship.
U.S. Options Markets
Stock Options
Stock Index Options
Futures Options
LEAPS
Interest Rate Options
Flex Options
Exotic Options
Futures Options
Gives the buyer the right to acquire a position in a futures contract. A long position in the case of a call
option. A short position in the case of a put
option.Futures options are the option of
choice in the fixed-income market.
Reasons for Popularity of Futures Options
Futures options on Treasury coupon futures do not require payments for accrued interest to be made.
Futures options are believed to be cleaner instruments due to reduced likelihood of delivery squeezes.
To price any option, it is necessary to know the price of the underlying asset at all times.
