Fundamental and types of option
The option is fundamentally different from the forward, future, and swap contracts. An option gives the holder of the option the right to do something. The holder of the option does not have to exercise this right. By contrast in a forward contract, future, or swap contract.
In mechanics of option explained. The two parties have committed themselves to some action underlying assets. These assets included stock, stock indices, foreign currencies, and futures contracts.
i)Stock option:-Option trade on more different stocks worldwide stock exchange one contract gives the holder the right to buy or sell a share at a specified price.
ii)Foreign currency option:-The major exchange trading foreign currency option is the Philadelphia stock exchange. The size of one contract depends on the currency.
iii)Index option:-Many different index options currently trade throughout the world. The most popular exchange is the S&P500 Index, Chicago board(CBOE) option exchange, Boston options exchange, Eurex exchange, NYSE Arca, Index national securities exchange(ISE).
iv)Future option:-In future option, The underlying asset is the futures contract. The future contract normally matures shortly after the expiration of the option. Future options are now available for most of the assets in which future contracts traded and normally traded on the same exchange as the future contract.
Specification of stock option
Stock option specification explained the expiration date the strike price, terminology fix option, dividends stock splits.
i)Expiration dates:-One of the item used to describe a stock option in the month in which the expiration date occurs.
ii)Strike price-Strike price is that price where stock option exercised on the maturity date, usually maturity date last Thursday of the month in European option.
iii)Terminology:-For any given time, Many different options contracts may be a trading option referred to as in the money at the money or out the money. An in-the-money option would. Give the holder a positive cash flow if it exercised immediately.
Similarly, an at the money option would lead to a zero cash flow, if it were exercised immediately, and the out-of-the-money option would lead to negative cash flow if it were exercised immediately.
iv)Fiex option:-Fiex option on equities and equity indices. These are an option where the traders on the floor of the exchange agree to nonstandard terms. These nonstandard terms can involve a strike price or an expiration date that is different from what is usually offered by the exchange.
It can also involve the option of being European rather than American.Flex options are an attempt by options exchange to regain business from the over-the-counter market. The exchange specifies a minimum size for flex option trades.
v)Dividend:-The early over-the-counter option dividend protected. If a company declared a cash dividend the strike price for options on the company’s stock was reduced on the ex-dividend day by the amount of the dividend.
Exchange-traded options are not generally adjusted for cash dividend occurs, there is no adjustment to the term of the option contract.
vi) Stock split:-Exchange-traded options adjusted for stock splits. A stock split occurs when the existing share is “split” into more shares. For example, in a 3-for-1 stock split, three new shares issued to replace each existing share.
Because a stock split does not change the assets or the earning ability of a company, we should not expect it to have any effect on the wealth of the company’s shareholders.
vii)Position limits and exercise limits: -A position limit for option contracts. This defines the maximum number of option contracts that an investor can hold on one side of the market.
For this purpose, long calls and short puts considered to be on the same side of the market. Also, short calls and long puts considered to be on the same side of the market. The exercise limit equals the position limit.