In finance, an option is a contract which gives the owner (holder) a right but not an obligation. Options are financial derivatives.
- A European-style call option gives the owner of the option the right to buy the underlying asset or instrument at a specified price on the expiration day.
- An American-style call option gives the owner of the option the right to buy the underlying asset or instrument at a specified price until the expiration day.
- A European-style put option gives the owner of the option the right to sell the underlying asset or instrument at a specified price on the expiration day.
- An American-style put option gives the owner of the option the right to sell the underlying asset or instrument at a specified price until the expiration day.
- A call option gives the owner the right to buy.
- A put option gives the owner the right to sell.
- The individual, company or other legal entity that creates an option, and is responsible for honoring it, is called the writer.
- The specified price is called strike price or exercise price.
- When you purchase an option, the purchase price you pay is called the premium.
The terms of an option will be specified in the term sheet. This is where you find information about basic things (is this a call option or a put option?) as well as more advanced issues such as settlement terms.
Before you purchase any option, make sure you know at least the following:
- Is it a call option or a put option?
- What is the underlying asset or instrument? (Example: shares of Merck B stock)
- What is the quantity of the underlying asset or instrument? (Example: 200 shares)
- What is the strike price? (Example: 65 USD per share, for a total of 1,300 USD)
- The terms by which the option is quoted in the market to convert the quoted price into the actual premium.
- Expiration date (Example: January 31, 2016)
- European-style option, American-style option or something more unusual? On what date or which dates can you exercise the option?
- What are the settlement terms? Is the writer obliged to deliver the actual asset on exercise, or is the writer allowed to deliver the equivalent in cash instead?
- Who is the writer? Who is guaranteeing to honor this option?
Binary options work very differently from other types of options. They do not give the owner a right, nor an obligation. They are financial instrument where the broker take the opposite position to yours and were either you or the broker end up earning money. You can read more about how binary options work by reading our article here.
3 best brokers:
- IG Index: IG index offer very high returns on binary options that matures in the money. The selection of binary options is small but the broker remain one of the best options for traders that are looking for high returns. Read more about IG Index.
- IQOption: IQOption is a relatively new broker that was founded in 2013. The broker is licensed in the UK and is a very good choice for our English readers that are looking for a good reliable broker. Read more about IQOption.
- AnyOption: AnyOption was one of the first brokers to offer binary options. They offer a large selection of binary options. AnyOption offer both classical binary options and exotic options. They do not offer any bonus. Read more about Anyoption.
Options are traded both over the counter (OTC) and on exchanges. A notable exception is employee stock options, for which there is almost no secondary market. In general, employee stock options must be exercised by the original holder (or allowed to expire) and can not be sold on.
The underlying asset or instrument for options can be many different things. Examples of common underlyings are currency, commodity, equity, bonds or futures contracts.
Options trading on exchanges
On exchanges, it is normally standardized options contracts that are listed. They each have a ticker symbol and their prices are tracked.
Typically, fulfillment of the options contract will be backed by the credit of the exchange. The actual counterparts can remain unknown to each other. The options are settled through a clearinghouse.
Exchanges bot set and enforce regulations.
Examples of common exchange-traded options: stock options, interest rate options (including bond options), stock market index options, futures contracts options, callable bull/bear contract options
Options trading over-the-counter
When options are traded outside exchanges, between two independent parties, it is called over-the-counter (OTC) trading.
OTC trading is more common for non-standardized options contracts that have been tailor-made for specific business requirements (“dealer options”).
In many cases, at least one of the counterparts will be a well-capitalized institution.
OTC option trading is not subject to exchange regulations.
Examples of common OTC-traded options: interest rate options, currency cross rate options, swaps options, swaptions