In finance, options are a type of derivatives. If you are the holder (owner) of an option, you have a right but not an obligation to carry out a certain transaction. The holder of a call option has the right to buy the underlying asset or instrument at a specified price, while the holder of a put option has the right to sell the underlying asset or instrument at a specified price. The specified price is called the strike price.
The entity (such as a company or an individual) that creates an option is called the writer. The writer is responsible for honoring the contractual obligation, should the holder of the option chose to exercise his or her right.
The underlying asset or instrument of an option can be almost anything. Common examples include commodity, bonds, currency, futures contracts and equity.
When can I exercise the option?
This depends on the type of option. The two most commonly occurring types are American-style options and European-style options. A European-style option can only be exercised on the expiration day. An American-style option can be exercised on any day until the expiration day.
Options are traded both over the counter (OTC) and on exchanges. The price you pay when you buy an option is called premium.
OTC trading of options is when options are traded outside exchanges. Non-standardized options tailor-made for specific purposes (e.g. the needs of a certain company to mitigate its commodity risk) are typically traded OTC. Other examples of options commonly traded OTC are currency cross rate options, swaptions and interest rate options.
Standardization of options contracts makes it possible for them to be traded on exchanges. Each option traded on an exchange will have its own ticker symbol. Options traded on exchanges are subject to exchange rules and regulations, enforced by the exchange. Also, exchange traded options are typically backed by the credit of the exchange. The options are settled through a clearinghouse, and you might not know the identity of your actual counterpart. Examples of options commonly traded on exchanges are stock options, stock market index options, futures contracts options, bond options and other interest rate options, and callable bull/bear contract options.
Trading employee stock options?
Employee stock options can normally only be exercised by the original holder. Therefore, there is practically no secondary market for such employee stock options.
The option’s term sheet is where you will find information about the option. This is for instance where you can find what the underlying asset or instrument is, he quantity of the underlying asset or instrument, the strike price, if it is a call option or a put option, the expiration date, who the writer is, and if it is an American-style option, a European-style option or something else. The term sheet will also show the terms by which the option is quoted in the market and the settlement terms.