An option contract is a form of financial asset called a derivative. The purchase of an option contract allows you to buy or sell certain underlying assets under specific conditions. You choose a price and a date on which to exchange this asset. When the time comes, you can choose to execute the contract if it's profitable, or let it expire if you don't. Here's what you need to know about option contracts.
What are the options?
While traders can base an option contract on virtually any tradable asset, the most common come in two forms:
Commodity option, trading in tangible assets and raw materials;
Stock options, commercial actions of a company.
In an option contract, you have the right to buy or sell an underlying asset at a specific price and date. On the expiration date, your earnings, if any, come from the difference between the current market price of the asset and the price of your contract. This is why option contracts are called derivatives because they derive their value from an underlying asset.
Much of the value of the contract comes from the fact that you can only choose to complete this transaction if it is profitable on the expiration date. For example, suppose you have an option contract to buy 1,000 ounces of coffee on January 1 for $ 1.10 per ounce. On January 1, when this contract expires, you can choose to exercise it or not, depending on whether it is profitable.
There are two types of option contracts: call and put.
Purchase options: this contract gives you the right to buy an underlying asset at a specific price and date. Call options are profitable if the price of the asset increases. For example, in the example above where you have an option to buy coffee at $ 1.10 an ounce on January 1, the option will be profitable if the coffee costs $ 1.20 on January 1, because your contract allows you to buy coffee for $ 0.10 less than it's worth on January 1st.
Put options: this contract gives you the right to sell an underlying asset at a specific price and date. Put options benefit if the price of the asset decreases. For example, suppose you have an option to sell coffee for $ 1.10 on January 1. If the price of coffee drops to $ 0.90 on January 1, your contract will give you the right to sell it for $ 0.20 more than it was worth in January. a)
A contract that expires in a profitable position is called "on money". Unprofitable contracts are “cash-strapped”.
An Introduction to Options Trading is one of the first books to explain where the profit of option traders really comes from. Although people usually assume that this profit relates to bid-offer spreads, this book actually shows that there is a much more sophisticated way of making money when trading options.
You can buy or "write" an option contract for virtually any tradable asset, but most are written for products or stocks. In a commodity contract, the option refers to goods traded on traders' exchanges. These are physical goods and raw materials such as wood, iron, coffee and gold.
A stock purchase contract, more commonly known as a stock option, gives you the right to buy or sell stocks. These benefits are very common as benefits for corporate officers. Companies often offer stock options to executives as part of their compensation, in which they have the option of buying company shares at a certain price (usually low) after several years of employment .
How an option contract works
Each option contract has four specific components:
Assets: the underlying asset that is traded and by what amount.
Expiration date: the expiration date of the contract.
Exercise price: The price at which the underlying asset of the contract is traded on the expiration date.
Contract: the position of the option contract, either a put or buy option
So in our example contract, we would have the following:
Active - 1000 ounces of coffee
Expiration date - January 1
Exercise price - $ 1.10
Contract: a sales contract
This sample contract would entitle you to buy 1,000 ounces of coffee on January 1 for $ 1.10 per ounce. Let's say that on January 1, the price of coffee rose to $ 1.20 an ounce, a difference of $ 0.10. You would earn $ 100 (1,000 ounces for $ 0.10).
The options can be resolved in two different ways.
Physical Settlement: Under this contract, you have the right to buy or sell the underlying asset. For example, in our example contract involving coffee beans, a physical settlement contract would require you to purchase 1,000 ounces of coffee beans when the contract expires. It is rare with raw materials, but very common with stock options.
Cash Resolution: In a cash resolution, traders do not exchange the underlying assets.
What are the options?
While traders can base an option contract on virtually any tradable asset, the most common come in two forms:
Commodity option, trading in tangible assets and raw materials;
Stock options, commercial actions of a company.
In an option contract, you have the right to buy or sell an underlying asset at a specific price and date. On the expiration date, your earnings, if any, come from the difference between the current market price of the asset and the price of your contract. This is why option contracts are called derivatives because they derive their value from an underlying asset.
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Much of the value of the contract comes from the fact that you can only choose to complete this transaction if it is profitable on the expiration date. For example, suppose you have an option contract to buy 1,000 ounces of coffee on January 1 for $ 1.10 per ounce. On January 1, when this contract expires, you can choose to exercise it or not, depending on whether it is profitable.
There are two types of option contracts: call and put.
Purchase options: this contract gives you the right to buy an underlying asset at a specific price and date. Call options are profitable if the price of the asset increases. For example, in the example above where you have an option to buy coffee at $ 1.10 an ounce on January 1, the option will be profitable if the coffee costs $ 1.20 on January 1, because your contract allows you to buy coffee for $ 0.10 less than it's worth on January 1st.
Put options: this contract gives you the right to sell an underlying asset at a specific price and date. Put options benefit if the price of the asset decreases. For example, suppose you have an option to sell coffee for $ 1.10 on January 1. If the price of coffee drops to $ 0.90 on January 1, your contract will give you the right to sell it for $ 0.20 more than it was worth in January. a)
A contract that expires in a profitable position is called "on money". Unprofitable contracts are “cash-strapped”.
You can buy or "write" an option contract for virtually any tradable asset, but most are written for products or stocks. In a commodity contract, the option refers to goods traded on traders' exchanges. These are physical goods and raw materials such as wood, iron, coffee and gold.
A stock purchase contract, more commonly known as a stock option, gives you the right to buy or sell stocks. These benefits are very common as benefits for corporate officers. Companies often offer stock options to executives as part of their compensation, in which they have the option of buying company shares at a certain price (usually low) after several years of employment .
How an option contract works
Each option contract has four specific components:
Assets: the underlying asset that is traded and by what amount.
Expiration date: the expiration date of the contract.
Exercise price: The price at which the underlying asset of the contract is traded on the expiration date.
Contract: the position of the option contract, either a put or buy option
So in our example contract, we would have the following:
Active - 1000 ounces of coffee
Expiration date - January 1
Exercise price - $ 1.10
Contract: a sales contract
This sample contract would entitle you to buy 1,000 ounces of coffee on January 1 for $ 1.10 per ounce. Let's say that on January 1, the price of coffee rose to $ 1.20 an ounce, a difference of $ 0.10. You would earn $ 100 (1,000 ounces for $ 0.10).
The options can be resolved in two different ways.
Physical Settlement: Under this contract, you have the right to buy or sell the underlying asset. For example, in our example contract involving coffee beans, a physical settlement contract would require you to purchase 1,000 ounces of coffee beans when the contract expires. It is rare with raw materials, but very common with stock options.
Cash Resolution: In a cash resolution, traders do not exchange the underlying assets.
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