A share market is a place where the stocks and the shares of the company are traded. Stock market is also known as an equity market. But then things have been improving in the stock market. Nowadays people even trade in bonds and derivatives. Option is a type of derivative and we are going to know more about options in this article.
Options is a financial instrument. It is a derivative. This instrument is an agreement between the parties for a transaction which is going to happen in the future on an asset at price which is known as the reference price. The person who buys the option only has the right and not the obligation to execute the contract. The person who sells the option however has the obligation to execute the contract. The difference that is there between the value of the asset and the reference price including the premium that is derived on the basis of the time that is left to execute the contract is the price of the option. The asset is normally a bond or a stock or a currency. However there are different types of options. One can create an option for any kind of asset that is valuable.
When the buyer has the option to buy an asset at a particular price then that is called as a call option. Similarly when a seller has a right to sell some asset at a particular price it is called a put option. The reference price at which the buyer and the seller have decided to trade the asset is known as the exercise price or strike price. The entire procedure of triggering an option and carrying out the trading at a price that is agreed upon is called as exercising. Each option will have a date of expiry. The portion transaction has to be carried out within the expiry date. In case the transaction is not carried out within that date then the entire transaction becomes void and useless.
The seller takes up the obligation of the transaction and that is called as writing. The seller is also called the writer of the option because of this. So for taking up such obligation the writer gets a premium from the buyer. Hence when the buyer carries out the option then the seller has to deliver the asset or an equal amount of cash.
The originally buyer of the option has the right to sell It to another person. There are a lot of options that are created as per the standards and then they are traded among the public in anonymous exchange.
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Each and every option is an agreement between the buyer and the seller with specific terms and conditions. Option contracts are a little complex. But then they terms will normally have the following terms.
• Whether the person who is selling has the put option.
• Whether the person who is buying has the call option.
• The total quantity of the asset and also the class of the same. Say for instance 500 shares of ABC Company.
• Exercise price, which is otherwise known as the strike price. This is the price at which the asset will be traded when the option is exercised.
• The expiry date, this is date until which the option can be exercised. If not exercised it becomes a void option.
• The terms of settlement that is whether the seller will be delivering the asset or the cash value which is equal to the value of the asset.
• The conditions based on which the option listed in the market so as to change the quoted price to actual premium. That is the amount the seller actually receives from the buyer.
There are different types of options. They are commodity option, options of future contracts, stock options and stock market index options.
There are over the counter options which are also known as the dealer options. This is an agreement between two parties. They are private parties and they are not listed in the stock exchange. The conditions of such over the counter options are not limited. The specifications of these kinds of options can be tailor made to suit the respective business. There is also another option called the employee stock option.