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OPTION: CONCEPT AND TYPES

Concept

An option belongs to the family of derivative securities. It is a contract that confers the right to its owner/holder but nor the obligation to buy or sell a specified security at a specified price on or' before a given date. Options are a special type of financial contracts in that the buyer of the option has the right to buy or sell the securities hut is under no obligation to do so. The buyer of the option is placed in an advantageous/favorable situation as he will exercise his option only when it is profitable to do so. In other words, the seller of the option is in disadvantageous position as he is under obligation to buy or sell the securities in case the buyer exercises his option. In operational terms, the seller/writer of the option runs the risk of loss for assuming which he charges option premium from the buyer of the option.

Some options are European while others are American. American options are more flexible in nature in that they can be exercised at any time up to the expiration date. In contrast, European options can be exercised only on the expiration date. In view of greater flexibility, most exchange traded options are American.

Types

Options are essentially of two types, namely, call options and put options.

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