Types of options
A financial option is a contract by which the option buyer acquires the right but not the obligation to buy or sell an underlying asset from the seller of the option.
The price at which the right to buy or sell the asset can be exercised is called the exercise price or also strike price. The right can be exercised until an established date or on a specific date called in both cases, the option's expiration date (Expiration Date).
The contract is formalized through the payment of a premium (Premium), or option price, by the buyer to the seller. Throughout the term of the contract, the seller of the option is subject to the obligation to sell or buy the underlying asset, at the moment in which the buyer of the option exercises his right. If the right to buy or sell is not exercised, the seller of the option keeps the amount of the premium.
Types of options
Financial options can be divided into the following categories:
Depending on the right granted
Options are generically divided into call options (Calls) and put options (Puts). In its modality
more traditional options are called simple options or plain vanilla.
Buy options / call options
The buyer acquires the right, but not the obligation, to buy an underlying asset at a specified price, in a period of time not exceeding a stipulated date. The seller of the call option assumes the obligation to sell the underlying asset, if the option is exercised.
Put options / put options
The buyer acquires the right but not the obligation to sell the underlying asset at a specified price, in a period of time not exceeding a stipulated date. The seller of the put option assumes the obligation to buy the underlying asset, if the option is exercised.
Generic categorization of options
Options within the currency - In the money
We will say that a call option is within the currency or in the money, when the price of the underlying asset is higher than the strike price. In the case of a put option, the price of the underlying asset must be below the exercise price.
Currency options - At the money
We will say that a call or put option is at the currency or at the money, when the strike price equals the price of the underlying asset.
Out of the money options - Out of the money
We will say that a call or put option is out of the currency or out of the money, when it is not exercisable.
Depending on the period of exercise
European options / European options
A European type option can only be exercised on the expiration date. The exercise price is fixed and the reference to settle the contract is the price of the underlying asset in the spot market (Spot Price), on the expiration date. Options on the IBEX 35 and Eurostoxx 50 indices are two examples of European options on organized markets.
American options / American options
An American option can be exercised at any time until the expiration date. The exercise price is fixed and the reference for the settlement of the contract is the price of the underlying asset in the cash market. Stock options traded on organized markets are usually of the American type, as is the case with those contracted at MEFF.
Depending on the methods of valuation of the exercise price, the settlement price and the conditional variables of an option contract
The options Path-Dependent
Path-Dependent options are a family of options whose value does not depend only on the price that the underlying asset reaches at maturity, but on its evolution and behavior throughout the term of the contract.
They are similar options to the plain vanilla options, except that the price used, either for their settlement or for the determination of the exercise price, is obtained by means of the arithmetic or geometric mean of a sequence of prices of the underlying asset, observed throughout of the period of validity of the contract.
They are options that are activated or deactivated when the underlying asset reaches a certain level, called a barrier. The contract starts with an option activated or deactivated. When the option is activated, it becomes a plain vanilla option for the remainder of the contract term. When deactivated, the option contract ceases to exist.
The lookback options
The value of a lookback option at expiration depends on the maximum or minimum price reached by the underlying over the term of the contract. We will distinguish two modalities:
1. With exercise price
The strike price is determined based on the most favorable price of the underlying asset over the life of the option. At expiration, the buyer of the call buys at the minimum price reached by the underlying throughout the term of the option. The put buyer sells at the maximum price.
2. With fixed exercise price
The settlement price of the underlying is the most favorable price observed during the life of the option. At expiration, the buyer of a call settles the contract with a settlement price equal to the maximum price of the underlying observed during the life of the option. The buyer of a put liquidates with a liquidation price equal to the minimum price of the underlying observed during the life of the option.
The options ladder or ladder
The options ladder They allow the consolidation of the profit generated by an option contract, when the underlying asset reaches pre-established levels at the beginning of the contract. The strike price is fixed.
At expiration, in the case of a call ladder option, the price of the underlying asset for the settlement of the contract is the highest of the pre-established ladder levels and the spot reference of the underlying. In the case of a put ladder, it is the lowest of the preset ladder levels and the spot reference of the underlying.
The options shout
It is a traditional plain vanilla option that allows the buyer of the same and in a discretionary way, to readjust the exercise price of the option a predetermined number of times to pre-established levels, which can be either the market price of the underlying at the time of the readjustment, or other levels, depending on the case.
The Cliquet options
It is an option whose exercise price changes throughout the term of the contract.
A bermuda option is a hybrid between a traditional European and American option.The general conditions are the same as in the case of simple options, except that a Bermuda option can only be exercised on certain dates, pre-established at the beginning of the contract.
Premiums are usually more expensive than a European option and cheaper than an American option.
Its use is frequent in convertible or exchangeable bond issues.
A chooser option offers the buyer of the same, the possibility of being able to choose on a certain date if the purchased option is a put or a call. The buyer of a simple type chooser option can choose, on a certain date, between a call or put option with the same strike price and the same expiration date.
The buyer of a complex type chooser option can choose, on a certain date, between a call or put option of different strike prices and maturities.
Chooser options are contracted in periods of high volatility and indefinite trend.
A compound option is an option whose underlying is another option contract. Therefore, there are 4 types of composite options:
a) Call on Call: bullish expectation (right to buy a call).
b) Call on Put: bearish expectation and more common contract (right to
buy a put).
c) Put on Call: bearish expectation (right to sell a call).
d) Put on Put: bullish expectation (right to sell a put).
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