An Option is an agreement between two parties regarding transaction of an asset at a pre-determined time (expiration date) and price (strike price). A key feature of option is that it derives its value from the price of other assets like securities, stock market indices, interest level, exchanges, etc.
It is for this reason, that it is also called a “derivative”. This investment option is much more appealing to investors owing to its flexible legal terms and conditions.
Features of Option Contract
One who buys the options contract gains right to ownership. However, the onus is on the seller and not the buyer, to fulfill the transaction.
The owner is entitled to sell his asset on or before the given date. However, the owner incurs 100% loss on the options if he tries to sell it post the given date.
The two categories of options are: Call Option and Put Option.
– The buyer of Call Option has the right to the asset but he is not compelled to buy the same, while the seller is obligated to sell the option within the specified time.
– Contrary to Call option, the Put Option holder has the right but not the obligation to sell the options, but, the seller is obligated to buy the options in case of buyer’s discretion.
Types of Option Contracts
The options contract can take various forms. They are:
EXCHANGE TRADED OPTION: Also known as “listed option”, it is traded on the basis of the terms of a regulated exchange. Standardization of contract is necessary to have a prior knowledge of the value and quantity of the underlying asset, expiration date, and strike price.
OVER THE COUNTER OPTION: Unlike exchange traded options, the contract is essentially unregulated. The terms of the agreement are flexible so that the parties involved can alter them to suit their needs.
EMPLOYEE STOCK OPTION: This kind is most common in US. The companies usually award their employees with such a contract as incentive compensation.
REAL ESTATE OPTION: These are contracts to pull together large parcels of land in which the premium that the buyer pays usually takes the form of mortgage loan.