WHAT ARE OPTION ? AND TYPES OF OPTION

OPTION

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.

CALLS AND PUTS

The two types of options are calls and puts:

A call gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires.

A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires.

Participants in the Options Market

There are four types of participants in options markets depending on the position they take:

·              Buyers of calls

·              Sellers of calls

·              Buyers of puts

·              Sellers of puts

People who buy options are called holders and those who sell options are called writers; furthermore, buyers are said to have long positions, and sellers are said to have short positions.
Here is the important distinction between buyers and sellers:

Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights if they choose.

Call writers and put writers (sellers), however, are obligated to buy or sell. This means that a seller may be required to make good on a promise to buy or sell.

Types Of Options

There are main types of options:

American options can be exercised at any time between the date of purchase and the expiration date. Most exchange-traded options are of this type.

European options are different from American options in that they can only be exercised at the end of their lives.

Long-Term Options
So far we've only discussed options in a short-term context. There are also options with holding times of one, two or multiple years, which may be more appealing for long-term investors. These options are called long-term equity anticipation securities (LEAPS). By providing opportunities to control and manage risk or even to speculate, LEAPS are virtually identical to regular options. LEAPS, however, provide these opportunities for much longer periods of time. Although they are not available on all stocks, LEAPS are available on most widely held issues.
Exotic Options
The simple calls and puts we've discussed are sometimes referred to as plain vanilla options. Even though the subject of options can be difficult to understand at first, these plain vanilla options are as easy as it gets! Because of the versatility of options, there are many types and variations of options. Non-standard options are called exotic options, which are either variations on the pay-off profiles of the plain vanilla options or are wholly different products with "option" embedded in them.