What is Option Agreement?
241 reads · Last updated: December 5, 2024
An options contract is an agreement between two parties to facilitate a potential transaction on an underlying security at a preset price, referred to as the strike price, prior to or on the expiration date.
Definition
An option agreement is a contract between two parties that grants the right, but not the obligation, to buy or sell an underlying security at a predetermined price (known as the strike price) before or on the expiration date. It provides the buyer with the right to execute a transaction at a specified price.
Origin
The concept of options dates back to ancient Greece, but the modern options market began with the establishment of the Chicago Board Options Exchange (CBOE) in 1973. This marked the start of standardized option contracts, making options trading more widespread and regulated.
Categories and Features
Options are primarily divided into call options and put options. A call option gives the holder the right to buy the underlying asset at a specific price before the expiration date, while a put option gives the holder the right to sell the underlying asset at a specific price before the expiration date. Features of options include leverage, limited risk, and diverse strategic applications.
Case Studies
A typical case involves trading options on Apple Inc. Investors can purchase call options on Apple to buy shares at the current price at a future date, profiting from a rise in stock price. Another example is Tesla Inc.'s put options, where investors can hedge against a decline in stock price by purchasing put options.
Common Issues
Common issues investors face with options include misunderstandings of option pricing models like the Black-Scholes model and neglecting the impact of time value. Investors should understand the time sensitivity of options and how market volatility affects option pricing.
