Syndicate
Stock Options
An option is a contract that gives to the buyer the right, not the obligation, to buy (call) or to sell (put):
- A determined quantity of financial tools (underlying assets)
- At prefixed price (exercise price)
- During a determined period (American option) or at the expiration of the contract (European option).
The salesman of the option for his part has, after receiving in exchange the premium payment (price of the option), the obligation to sell or buy the asset in question at the agreed price (exercise price) in case the buyer decides to exercise its right (exercise option).
The options about merchandise are being done for more than a century, but the options about securities are more recently.
For example, in Chicago, where there is an specialized market in financial options, that is considered the most important in the world, this type of operations are being realized since 1973. Other important option markets are London, Amsterdam and Philadelphia.
Option Characteristics
Basically we can distinguish between two types of options within the buying options (call options) and within the selling options (put options). So then, there will be four basic positions between the buying or selling options when buying or selling a call or put options.
- Buying a call option: The buyer of this type of options has the right, in exchange of a premium (amount paid for the option). To buy, at the expiration date if it’s about a European option or at any other moment until its expiration date if it’s about an American option, the underlying asset in which the option is based.
- Such operation is realized at a prefixed determined price on the contract (exercise price or strike price). The option buyer is said to be in a long position with options (long call).
- Selling a call option: the call option salesman has the obligation of selling the underlying asset before or at the expiration date (depending on the option) at the established price on the contract. This is done in exchange of the perception of the premium. So then, the salesman of a call option is required to satisfy the contracting requirements of the buyer. This option salesman is said to be in a short position with options (short call).
- Buying a put option: the buyer of this kind of option has the right, in exchange of the premium payment, to sell an underlying asset at the established price on the contract, at or until the expiration date depending again on the type of option. Then the buyer is said to be in a long position with options (long put).
- Selling of put option: the put option salesman has the obligation of buying the underlying assets established on the contract, at the expiration date or before depending on the kind of option, paying the established exercise price and always at the requirement of the buyer of the option. In exchange he receives the premium. Then the option salesman is said to be in a short position (short put).
In general terms, we see that those in short options positions, the salesmen, acquire a compromise against the other part, while those in long option positions, the buyers, don’t have such obligation buy they have the right to exercise or not the option. The decision to exercise or not the right incorporated within the option is entirely his choice. The buyer will only decide to exercise the option if the difference between the current price and exercise price (that of the market at the moment of exercising the option) is in his favor.
To be favorable implies obtaining some profit if the contrary he will not exercise the option.