Join our investing community

Option

Discussion in 'Investing Glossary' started by Glossary, 8th Feb, 2007.

  1. Glossary

    Glossary Active Member

    Joined:
    12th Sep, 2006
    Posts:
    25
    An option is an agreement which confers on the option holder the right but not the obligation to either buy or sell a specific asset (often a parcel of shares or real estate) at a stated price (the strike price) within a certain timeframe.

    The price paid for this right is called the option premium. If the option is not exercised by the expiration date then the option lapses and the premium is lost (but that is the total amount lost).

    Options may be either put options or call options.

    A put option permits the purchaser of the option to sell an asset to the writer of the option at a specified price at any time until the expiration date. The purchaser of the option can "put" his asset onto the option writer. Put options are often purchased to provide a degree of insurance against market falls.

    A call option gives the optionholder the right to buy an asset at a specified price at any time until the expiration date. A call option would be bought if you considered a share was likely to substantially rise in value before the expiration date. Conversely if you considered the share was likely to be relatively steady in value then you may write a call option over it to obtain income by way of the option premium. This would be a covered call. Writing an option over shares which you do not own is called a naked call.

    There are numerous other options strategies which share investors may employ.

    Options over a number of listed shares may be bought and sold on the Australian Stock Exchange these are called Exchange Traded Options or ETO.

    In contrast, some financial institutions will design an option specifically for a client to deal with a specific risk. Such an option is not listed on any exchange and is called an Over-the-counter or OTC option.

    Most options are "Amercian" options, a label which describes the fact that they may be exercised at any time up to and including the expiration date. In contrast "European" options may only be exercised on the expiration date.

    Options are a type of derivative.
     
    Last edited by a moderator: 8th Feb, 2007