Options

Abstract

Options are tradable derivate contracts that “derive” their value from other underlying instruments. Wikipedia defines these instruments as follows: “An Option is a contract which gives the buyer (the owner) the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price on or before a specified date [130].” They are similar to futures contracts in that they provide a mechanism to purchase or sell a certain physical or financial asset sometime in the future at a price that is known in the present.Whereas futures obligate the contract holder to purchase or sell the underlying asset at the agreed-upon price, options provide the “option” to purchase or sell the underlying asset at the agreed-upon price. This added flexibility or optionality comes at a premium. No upfront exchange of funds is required in order for the buyer and seller to enter into a futures contract. To buy an options contract, however, the buyer has to pay a premium. Similarly, the person selling the option contract gets to collect the premium.