Options are contracts between a option writer and a buyer that gives the buyer the right to buy/sell the underlying such as assets, other derivatives etc. at a stated price on a given date. Here, the buyer pays the option premium to the option writer i.e the seller of the option. The option writer has to oblige if the buyer decides to exercise the right given through the options contract.
Two types of options are :
|Definition||Buyer has the right, but is not required, to buy an agreed quantity by a certain date for a certain price (the strike price).||Buyer has the right, but is not required, to sell an agreed quantity by a certain date for the strike price.|
|Costs||Premium paid by buyer||Premium paid by buyer|
|Obligations||Seller (writer of the call option) obligated to sell the underlying asset to the option holder if the option is exercised.||Seller (writer of a put option) obligated to buy the underlying asset from the option holder if the option is exercised.|
|Value||Increases as value of the asset increases||Decreases as value of the underlying asset increases|
|Analogies||Security deposit – allowed to take something at a certain price if the investor chooses.||Insurance – protected against a loss in value.|