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OPTIONS - Coggle Diagram
OPTIONS
Features
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Options provide leverage, allowing investors to control a larger position in the underlying asset with a smaller upfront investment. This can amplify both potential gains and losses.
The price the option buyer pays to the option seller for the rights conveyed by the option contract. It represents the cost of holding the option and is determined by various factors, including the current market price of the underlying asset, the strike price, and the time remaining until expiration.
Options are often used to hedge against adverse price movements in the underlying asset. For example, a stockholder can buy put options to protect against a decline in the stock's value.
The date when the option contract expires. After this date, the option is no longer valid, and the right to exercise it ceases.
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The price at which the underlying asset can be bought (for a call option) or sold (for a put option) if the option is exercised. It is also referred to as the exercise price.
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An option derives its value from an underlying asset, which can be a stock, bond, commodity, currency, or even another derivative.
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OPTIONS PREMIUM
For option buyers, the premium represents their maximum potential loss. For option sellers, the premium represents their maximum potential profit, but their potential losses can be substantial.
As an option approaches its expiration date, its time value typically decreases more rapidly. This phenomenon is known as time decay or theta decay.
In the options market, there is typically a bid-ask spread, representing the difference between the price at which buyers are willing to purchase the option (the bid) and the price at which sellers are willing to sell the option (the ask).
Intrinsic Value
This is the portion of the premium that represents the immediate, realizable profit that an option would provide if it were exercised immediately. For call options, the intrinsic value is the difference between the current market price of the underlying asset and the strike price (if positive). For put options, it is the difference between the strike price and the market price of the underlying asset (if positive).
Time Value
The time value is the part of the premium that exceeds the intrinsic value. It reflects the potential for the option to gain additional value before expiration. Time value is influenced by factors like time to expiration, implied volatility, and the level of interest rates. As time passes, all else being equal, the time value of an option tends to decrease, a phenomenon known as time decay.
The premium is the cost associated with buying an option.ThThe premium's value is determined by various factors, including the current market price of the underlying asset, the option's strike price, the time remaining until expiration, market volatility, and interest rates.
- Factors Affecting Premium
Volatility
For options on stocks, the timing and amount of dividends can affect premiums, particularly for call options.
Interest Rates
For options on stocks, the timing and amount of dividends can affect premiums, particularly for call options.
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Dividends
The In-the-moneyness and Out of-the- moneyness will change depending on whether the Strike is higher than the Spot.
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An option premium, often simply referred to as the "premium," is the price that an option buyer pays to an option seller (or writer) to acquire the rights granted by the option contract.
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Types
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Based on the Complexity
Plain Vanilla
Vanilla options, also known as plain vanilla options, are standardized and straightforward option contracts with simple terms and features. They are the most basic form of options and serve as the foundation for understanding options trading.
Exotic
Exotic options, on the other hand, are non-standardized and often more complex option contracts. They incorporate unique or non-traditional features and are tailored to specific trading or hedging needs.
Exotic options are typically less liquid and less actively traded than vanilla options because they are customized to meet specific requirements.
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Options PAYOFF
Call Option
ATM
• CMP is equal to the Strike Price • If the buyer exercise the option, he might or might not receive the cash flow.
OTM
• CMP is lesser than the Strike Price • If the buyer exercise the option, he will not receive the cash flow.
ITM
• CMP is greater than the Strike Price • If the buyer exercise the option, he will receive the cash flow.
Put Option
ATM
• CMP is equal to the Strike Price • If the buyer exercise the option, he might or might not receive the cash flow.
OTM
• CMP is greater than the Strike Price • If the buyer exercise the option, he will not receive the cash flow.
ITM
• CMP is lesser than the Strike Price • If the buyer exercise the option, he will receive the cash flow.
Disadvantage
• Lower liquidity • Higher spreads • Higher commissions • Complicated • Time decay • Less information • Options not available for all stocks
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An option contract is a financial derivative that gives the holder the right, but not the obligation, to buy (call option) or sell (put option) a specific underlying asset at a predetermined price (strike price) within a specified period of time (expiration date).