Option Meaning:
An option is a contract, which gives the buyer the right, but not the obligation to buy or sell shares of the underlying security at a specific price on or before a specific date.In simple words , it is a contract between a buyer and a seller that gives the buyer the right, but not the obligation, to buy or to sell a particular asset on or before the option’s expiration time, at an agreed price, the strike price. In return for granting the option, the seller collects a payment (the premium) from the buyer.
Options are popular as the buyer has limited investment and potentially unlimited profits.
Types of options
The primary types of financial options are:
Exchange traded options are a class of exchange traded derivatives. Exchange traded options have standardized contracts, and are settled through a clearing house with fulfillment guaranteed by the credit of the exchange. Exchange traded options include:
o stock options,
o commodity options,
o bond options and other interest rate options
o stock market index options or, simply, index options and
o options on futures contracts
Over-the-counter options are traded between two private parties, and are not listed on an exchange. The terms of an OTC option are unrestricted and may be individually tailored to meet any business need. Option types commonly traded over the counter include:
1. interest rate options
2. currency cross rate options, and
3. options on swaps or swaptions.
Employee stock options are issued by a company to its employees as compensation.