Understanding Options As A Financial Instrument
In this brief article, we give a summary of what is an option, what is a commodity option and the two main categories of options employed for financial trading.
Definition: A derivative financial tool where two entities agree to transact an asset. Options are contractual with a specified price and agreement to fulfil the transaction before a future date.
What is it: An option gives an owner the ability to either buy an asset or sell it for a set price before a given date. It is not mandatory for the owner to buy or sell the option. If the option is not exercised before the stated future date, it is rendered of no value.
Types of Options: There are two chief categories of options, call and put.
• A call option gives the owner the authority to buy an asset before or at a set time on a quantified price.
• An option that is put provides the owner with the permission to sell an asset before or at a set time at a particular price.
The holder of a put option assumes that the value of the asset being sold will become lower than the exercise price before the expiry date. The holder of the call option, on the other hand, speculates the opposite, i.e., that the value of the asset will increase.
What’s a commodity option: A contract that gives a buyer the option to sell or buy a commodity at a set price and a fixed future date is called a commodity option. An example will make it clearer. Let’s say a trader takes the commodity option to buy a bushel of wheat for 100 bucks till the 20th of September. If the market price of wheat per bushel increases by 10%, the trader profits because his exercise price is set at 100.