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PRINCIPLES OF OPTIONS, Exchange-Traded Options, Factors Affecting Option…
PRINCIPLES OF OPTIONS
Definition & Concepts
Option, by simple definition, is a contract to buy and sell a specified asset at specified price and time.
Like futures, the price is agreed today but the fulfillment of the contract will be executed later.
Unlike futures, however, option does not oblige both parties to fulfill the contract.
As the name implies, one party will be given an "option" either to execute (exercise) or not execute his contract (right).
For this reason, an option is a contract that gives a buyer the right (choice) without an obligation to buy or sell an underlying instrument (specified asset) at the exercise price (specified price) until maturity of contract (specified time).
On the other hand, a seller has an obligation to sell or buy the underlying instrument only if exercised by the buyer.
This obligation is known legally as a contingent liability as it is only effective or becomes enforceable if the buyer exercises his right to buy or to sell.
To have a fair trading, for a buyer to acquire the "right", he is required today to pay a certain sum of non-refundable money known as a premium, while the seller will receive it in order to impose a contingent liability in the contract.
Therefore, a premium as the name may suggest, is an "extra" money which represents a cash-outflow (expense) to the buyer but a cash-inflow (income) to the seller.
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Put Option
A contract where the buyer has the right to sell and the seller has the obligation to buy in the future.
Call Option
A contract where the buyer has the right to buy and the seller has the obligation to sell in the future
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- Price Of The Underlying Asset
- Strike Price
- Expiration Time
- Interest Rate
- Market Volatility
- Dividends
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