What is an option contract? What is it for? We will answer these and other questions in the article. An option is an agreement under which the acquirer of an option (a potential trader or a probable purchaser of the underlying asset - products, securities) does not receive an obligation, but the right to sell or purchase this asset at a price agreed in advance, at a time specified in the agreement in the future or for the duration of period of time. In this case, the seller of the option is obliged in response to sell or acquire the asset in accordance with the terms of the realized option.
Tool
An option is called one of the financial derivatives. Differentiate the options for the acquisition (call option), implementation (put option) and mutual (double option). Futures and options are largely similar financial instruments, but they have some fundamental differences.
Types of options
What types of option contracts are there? Options are divided into several qualifications. By instrument:
- currency (for currency or cash futures);
- interest (interest on futures, interest rates);
- stock (for index futures or stocks);
- commodity (for commodity futures or physical goods).
By repayment:
- a European option can only be redeemed on a fixed date;
- The American option is redeemed on any day of the period until its completion.
There is also a group of option contracts, which differ in their additional amendments and reservations. Such options are called exotic (Asian, barrier, swaptsion, complex). Many of them arose in isolated areas against the background of the original situation of doing business.
Story
How did option contracts come about? They have been used for several centuries. During tulip mania in the 1630s, commodity options and futures were used (the buyer received the right to sell and buy bulbs in the future at a predetermined price). With the help of options, those who could not afford to buy even one onion could enter the tulip market.
In the 1820s, stock options arose on the London Stock Exchange. In America, an over-the-counter stock and commodity option market was already created in the 60s. Exchange trading in stock options on the United States debuted in 1973, when the option Chicago Exchange (OWN) was created. In the early 1990s, a wide range of options was created on the OTC secondary markets for secondary devices that could satisfy various financial needs.
In Russia, the leading platform on which options are traded is the Derivatives Market of the Moscow Exchange.
FX options
So, you already know what an option contract is. FX options is one of its varieties. It is used on the Forex market, where a person who wants to purchase an option has the right to set a date for exchanging one currency for another at the exchange rate agreed upon in advance.
Mostly, FX options are used by exporters and importers to insure the risks of rate changes between the currency of sale and purchase of products on the domestic market and the currency of the foreign economic agreement. In fact, with the help of options, companies reduce the level of currency risk to the total number of option premiums.
OTC and Stock Options
What is an exchange option contract? This is a standard agreement, the treatment of which is similar to futures (futures contracts). For such an option, the exchange indicates the specification of the agreement.Concluding a deal, bidders negotiate only the amount of time for an option, all other parameters and standards are determined by the exchange. An option quote published by the exchange is the average value of the premium for this option per day.
From the point of view of exchange commerce, options with different selling dates or prices are considered different agreements. The Clearing House shall keep records of positions participating in each option agreement.
That is, the bidder can purchase one contract, and if he sells such a contract, then his position is closed. The Exchange Clearing House is the reverse side of the transaction for each option contract. For exchange options, there is also a system for extracting margin fees (usually paid only by the seller of the option).
Non-typed over-the-counter options, as opposed to exchange-based ones, are concluded on free criteria that participants set when making a transaction. The technology of conclusion is close to forward contracts. Today, the main clients of the OTC market are large financial institutions that need to hedge open positions and their portfolios. They may need end dates unlike standard dates. Mostly reputable investment companies are the main traders of OTC options.
Exchanges seek to move over-the-counter commerce to a market exchange site. FLEX options have arisen that have conditions that can be used to vary strike prices and expiration dates.
Operations
As mentioned above, the types of option contracts are put option (exercise option) and call option (purchase option). Accordingly, four types of operations are possible with options:
- write out (sell) a call option;
- acquire call option;
- write out (sell) a put option;
- acquire put option.
Option premium
What are the features of option contracts? Find out what the option premium is. This is the money paid by the option purchaser to the trader upon conclusion of the option contract. A bonus in essence is a fee for the right to perform an action in the future.
Often, when they say the phrase “option price”, they mean the option premium. A stock option premium is a quote on it. Usually its dimensions are established as a result of adjusting the supply and demand in the market between sellers and buyers of options. In addition, there are mathematical models with which you can calculate the premium based on the current value of the main asset and its probabilistic properties (profitability, volatility, and so on).
The premium calculated in this way is called the theoretical value of the option. In most cases, it is calculated by a broker or trade organizer and is available along with quotation data during the sales period.
Price samples
Options contracts - the concept, essence, classification, profitability - are studied by many experts. It is known that at the base of all mathematical samples for calculating the value of an option lies the concept of an effective market. It is understood that the “objective” option premium is equal to its value, at which neither the seller of the option nor the buyer receive an average profit.
To calculate the premium, the qualities of the stochastic movement, imitating the behavior of the value of the underlying asset, located at the root of the option contract, are postulated. The parameters of such a model are estimated on the basis of historical information. One of the most important statistical rules affecting the size of the premium is the volatility of the value of the base fund. The more significant it is, the greater the inaccuracy in forecasting the upcoming price and the larger the premium (for danger) that an option seller is supposed to receive (however, for example, for barrier shutdown options, the subordination is the opposite, since the higher the volatility, the greater the possibility of reaching the barrier).
The second important parameter, also directly related to uncertainty, is the time until the option expires. The farther from this dating, the more significant the premium (for the same cost of supplying the main asset specified in the option agreement). Also, the value of the option is affected by dividends from the underlying asset and interest rate.
In the case of European options, it is often possible to find a formula for calculating their value. In the case of US options, as a rule, numerical methods are used.
Known optional models
The most popular optional models are:
- Heston model;
- binomial;
- Black - Scholes model;
- Monte Carlo;
- Cox-Rubinstein;
- Bierksund-Stensland;
- Yats model.
Exotic
What are exotic options? An option contract, at the conclusion of which the scope of the contract, the type of underlying asset, the cost of sale or purchase, style and type, is called a “vanilla” (plain vanilla option) or standard (standard) option.
With the evolution of the market, additional terms began to be included in the terms of option agreements in response to customer requests caused by the qualities of the risk that they would like to insure with options. Since the OTC market is very flexible, additional reservations simply reflected on the size of the premium, increasing or decreasing it.
The most successful inventions began to be recommended in the market in droves. So there were extraordinary (non-standard) and exotic (exotic options or just exotic). It is said that exotic options appeared in the late 80s. These include:
- barrier option;
- Asian;
- binary;
- complicated;
- range option;
- swaption.
Futures
Futures and options contracts differ in some parameters. Futures is a financial derivative, an urgent standard exchange agreement for the sale of an underlying asset, upon creation of which the parties (buyer and seller) agree only on the delivery time and price level. The remaining parameters of the asset (quality, quantity, labeling, packaging, etc.) are agreed upon ahead of time in the classification of the exchange agreement. Parties to the exchange are liable up to the execution of the futures.
Futures can be interpreted as a standardized variation of a forward, who trades in an orderly market with mutual settlements integrated within the exchange.