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OPTIONS (What is option? (Agreement between 2 parties (Buyer -…
OPTIONS
What is option?
A contract that gives the buyer of option the right, but not the obligation to buy or sell an underlying asset at a specified strike price, on or before a specified date
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Underlying assets: Stocks, debt instruments (bonds), currencies
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Options Terminologies
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Value of Option
Premium of option, which is made up of 2 components
Intrinsic Value: profit that can be realised by exercising the option (the lowest will always be 0). An ITM option has a positive intrinsic value as strike price is lower than spot, thus by exercising the option, buyer of option will make a profit. On the other hand, OTM AND ATM will not make profit, which means they have 0 intrinsic value.
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May be 0, if its not profitable to exercise
Extrinsic Value (Time value): The lowest will always be 0. The higher the time value, the longer time the buyer has in order to make more money as expiration is much later.
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Types of options
CALL
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Gives the buyer the right but not the obligation to BUY the underlying asset on/before pre-determined date at a pre-determined strike price
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PUT
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Gives the buyer the right, but not the obligation to SELL to the seller of option the underlying instruments at a pre-determined strike price
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