Introduction to Options Flashcards
option
a financial instrument that gives the buyer the right, but not the obligation, to buy or sell an asset at a specified price on or before a specified date.
traded on exchanges, and they are a popular way to hedge risk, speculate on price movements, or manage portfolios
Key features of Options
Two parties
Specified price
Specified date
Notional value
Premium (price that the buyer of the option pays to the seller)
Types of Options
Call options
Put options
Call options
gives the buyer the right to buy the asset at the strike price on or before the expiration date.
If the price of the asset is above the strike price on the expiration date, the buyer will exercise their option and buy the asset at the strike price.
This will result in a profit for the buyer, since they will be able to buy the asset for less than the market price.
Put options
A put option gives the buyer the right to sell the asset at the strike price on or before the expiration date.
If the price of the asset is below the strike price on the expiration date, the buyer will exercise their option and sell the asset at the strike price.
This will result in a profit for the buyer, since they will be able to sell the asset for more than the market price
American Options (AO)
Exercise: BEFORE expiration date
Premium: more expensive than EO
Flexibility: more flexible
Risk: riskier
European Options (EO)
Exercise: ON expiration date
Premium: less expensive than AO
Flexibility: less flexible
Risk: less risky
Risks in Options
Time decay (decreases over time)
Volatility risk (more volatile, the option will be more expensive)
Liquidity risk (difficult to sell)
