Economics Options And Futures Questions Medium
The key characteristics of options contracts are as follows:
1. Underlying Asset: Options contracts are financial derivatives that derive their value from an underlying asset, such as stocks, bonds, commodities, or currencies.
2. Exercise Price: Also known as the strike price, it is the predetermined price at which the underlying asset can be bought or sold, depending on the type of option (call or put).
3. Expiration Date: Options contracts have a specific expiration date, after which they become invalid. The expiration date determines the time period within which the option holder can exercise their right to buy or sell the underlying asset.
4. Option Premium: The option premium is the price paid by the buyer to the seller for acquiring the option contract. It represents the cost of holding the option and is influenced by factors such as the current market price of the underlying asset, time remaining until expiration, volatility, and interest rates.
5. Call and Put Options: Options contracts can be either call options or put options. A call option gives the holder the right to buy the underlying asset at the exercise price, while a put option gives the holder the right to sell the underlying asset at the exercise price.
6. Rights and Obligations: The buyer of an options contract has the right, but not the obligation, to exercise the contract. On the other hand, the seller (also known as the writer) of the options contract has the obligation to fulfill the terms of the contract if the buyer decides to exercise it.
7. Leverage: Options contracts provide leverage, allowing investors to control a larger amount of the underlying asset with a smaller investment. This amplifies potential gains but also increases the risk of losses.
8. Flexibility: Options contracts offer flexibility as they can be bought or sold in the market before the expiration date. This allows investors to adjust their positions based on changing market conditions or to profit from price movements without owning the underlying asset.
9. Limited Risk: The maximum risk for the buyer of an options contract is limited to the premium paid, while the potential profit is theoretically unlimited. For the seller, the risk is potentially unlimited, as they may be required to fulfill the terms of the contract at a disadvantageous price.
10. Hedging and Speculation: Options contracts are used for both hedging and speculation purposes. Hedgers use options to protect against adverse price movements in the underlying asset, while speculators aim to profit from price fluctuations by taking positions in options contracts.