Basic Training

Vocabulary Lesson: Option Trades

Options are simply contracts that provide the right to the buyer to either buy or sell an option at an agreed upon date in the future for a particular price. When the seller grants the buyer an option then a premium, which is a payment, is collected. Option trades appear complicated to those who are unaware of the trading process, but understanding the lingo and the trading method allows for practically anyone to get involved in option trades.

Call and Put Option Trades

When the buyer has the right to purchase an underlying asset this is called a “call” option. When the option buyer has the permission to sell an underlying asset it is called a “put” option. Underlying assets may be a futures contract, stock, or property. When a put option is purchased it gives the buyer the right to sell. Buying a call option gives the buyer the right to buy a specific amount of an underlying asset at a preapproved price. This price is called the strike price and must be acted upon before the security expires.

Exchange Option Trades

There are various kinds of option trades including exchange trade options. These options typically have contracts and a clearing house settles the trade. In most cases exchange option trades have pricing models. The most popular types of exchange option trades include commodity and stock options. Others include future contract options, bond options, index options, and interest rate options.

Dealer Option Trades

Dealer option trades are not on the exchange and occur between private parties. These are sometimes referred to as over the counter option trades. There are no standardized terms with deal option trades, which means they may be modified as necessary for various needs. There are several types of deal option trades including currency cross rate option trades, interest rate option trades, swaptions, among others.

Option Trades Value

There are various models that may be used to determine an option’s theoretical value. The reason models are developed is to allow traders methods by which to forecast how an option will respond to a continuously changing market.

Types of Option Trades

There are various types of option trades including American option, European option, Bermudan option, Exotic option, Vanilla option, and the Barrier option. Each of these options are based on specific types of trades. For example, the vanilla option is any option that is opposite of an exotic option. In simple terms, a “plain” option.