Options are the right but not the obligation to buy (call) or sell (put) the underlying asset at the strike price at or before the expiration date.
In exchange for these rights, the buyer of an option pays a premium. The seller of the option receives that premium. If the option expires In-The-Money, the seller is called on to perform.
- In the case of a call, if the stock is above the strike price at expiration the calls will be exercised. the seller of the call will deliver shares to the long call holder.
- In the case of a put, if the stock if below the strike price at expiration the puts will be exercised. The seller of the put will take delivery of the shares and pay the strike price for them.
The price paid for the option depends on the time left to expiration, the net cost to carry and the volatility of the underlying asset.
Options are rights not obligations. They have a truncated payout, not a linear (see hockeystick diagrams below).
There are many different types of options in the marketplace. None of them are eligible for Cleared Derivatives.
There are exchange traded equity Options, which trade on an electronic bulletin board and clear at the OCC.
Futures & Futures options also trade on an exhcange and clear at the TCC (futures options). Futures optoins include Financial Futures, Energy Futures, Agricultural Futures, Coffee, Sugar, Cocoa, Cotton & Foreign Currency Futures.
Interest Rate Options such as Caps, Floor & Swaptions trade OTC and clear Bilaterally. Their quoting convention is in basis points. WE use what is known as “notional” basis points (i.e., 100 bps on $1 million for a 2 year option= $100 total).
Foreign Exchange Options, trade OTC and clear bilaterally. Their quoting convention is in Implied Volatility. We quote FX options in implied volatility because we aren’t sure whether the client will want the EUR-USD option written as a USD call or a EUR put. Therefore it’s easier to put the price out in Implied Volatility terms and the salesperson to speak directly with the client about their specific needs.
Once we’ve clarified the Options Terminology we can focus on how the product is best used for our purposes; and what kind of research we should do.
When a call us purhcased, the buyer of the call is VERY BULLISH; The buyer of a put is VERY BEARISH
Conversely, The seller of a call is MODERATELY BEARISH; the sller of a put if MODERATELY BULLISH