Option Expiration Date & Price of the Exercise Period

Option Expiration Date
In reference to the expiration date, two great groups are distinguished on one hand there is the American case, where the rights of the buyers can be exercised at any date until its expiration, and on the other hand there is the case of Europe, where the rights must be exercised on the same expiration date.

So then, according to the expiration date, the options may be classified as:

• American options: they can be exercised at any moment until the expiration of the contract.
• European options: can only be exercised at the expiration date of the contract.

Most of the organized markets usually use the American option for presenting more flexibility in its negotiation with respect to the European option.

Apart from these two options, there exists a third possibility, the Asian option. They are so called, because of its origin and it doesn’t have any special characteristic with respect to the expiration date but there is with respect to the price of the underlying assets at the moment of exercising the option.

This price is calculated through the medium price of a determined period, usually on the period in which the option has been negotiated.

The finality of this type of options is to avoid the manipulation that the underlying assets suffer at the expiration dates when the manipulators seek a favorable price for their interests depending at how they stand with respect to the options, this is a usual practice within the Japanese markets, from there its denomination.

Price of the Exercise Period
The price of the exercise indicates the convenience or not has exercising the option when compared with the market price of the underlying assets in question. In this way it points out the possibility of obtaining a better profit if the difference between both is favorable.

• Buying a call buying option

As said before in reference to the type of options, at the long call position (buyer of buying option). The holder of the option has the right, but not the obligation, of buying at the prefixed price the underlying assets. The decision will be taken after comparing   the exercise prices and market prices of those underlying assets.

Three situations can be distinguished:

• If the market price of the underlying assets (s) is less than the exercise price (e) stipulated for that asst, the call option buyer will not exercise the option due that he can acquire those assets through the market at an inferior price than if using the option. So then, in this case the call buyer will obtain a limited loss on the premium paid (x) for the option. This situation is known under the expression of “out of money”, with which they indicate that the option is worthless.
• If the market price of the underlying asset (s’) is equal to that of the exercise price (E), the share holder is indifferent as to exercise it or not, due that the price of the underlying asset is the same at the market than if exercising the option. It is to emphasize that the will still loose the premium (x) paid for the option. This situation is known under the expression of “at the money”, which indicates that the option is in the money. To find in which point the option generates net profits, it is interesting to know the “break point”.

As long as the market price surpasses the break point, the call buyer will obtain rising profits.

In the section between the exercise point and the breaking point, the loss, limited to the premium, starts to diminish until it arrives to the break point where it nullifies itself. So, at this point the call buyer will exercise the option obtaining some results: S’- (E + X) 0= 1

It the market price (S”) surpasses the exercise price (E), the holder of the option will always exercise it, due that at this break point he will recover the initial investment, and from then on he will enter to A profit zone. This situation is known under the expression “in the money”, indicating that it finds itself within money, the option is of value.

The profits that the option holder may obtain at this situation are without limits and will only depend on how much the market price will rise until the expiration date.

So then, always that S E, the option   will be exercised. In this situation the profits of a long call will be:

S” – (E + X)  O.

Concluding, saying that the call option buyer has unlimited profit possibilities and of limited losses (for the premium). So then, the call buyer will be the investor with rising expectations with respect to the market prices and he will expect that the underlying asset will rise very much in its price.