Overview Of Options

Options provide for the right to buy or sell at a specified future date. The value of an option is determined by the value of its underlying asset. The strike price, or exercise price is the price in which the contract holders have agreed to call in the short position and put in the long position. At the option’s expiration date the option is worthless.

Call options are options to buy a security at a later date at the presently agreed upon price. Similarly, a put option is an option to sell a security at a later date at the presently agreed upon price.

It is advantageous to exercise call options early when the underlying firm is preparing to pay a substantial dividend which is valued higher than the value of the remaining time of the call.

American options may be exercised at any time between initiation and maturity. European options are easier to value as the may only be exercised at maturity and therefore, analysts only need to consider the value at the future date. American options have the same rights as European options plus more. Both American and European calls are more valuable the longer the expiration date as the uncertainty increases with the time to maturity. European puts are less valuable than American options. Although not as common, bermuda options may be exercised at a specified intermediate time between initiation and maturity.

Individuals write options to collect the premium. The writer estimates the price will increases whereas the seller estimates the price will decrease. As the volatility of the stock increases so does the value of the option written on the stock.

Portfolio insurance includes option based investments added to the present investments in order to protect the value of the fund from dramatic loss at the specified horizon date. An easy way to gain portfolio insurance on a diversified portfolio of common stock of U.S. companies is to buy a put on the S&P 500 stock index as it closely resembles the U.S. market.