Options are contracts between two parties. The contracts are binding but the risks aren’t evenly distributed i.e. only to one of the parties is bound by the contract.

An options contract may be executed over the counter (OTC) i.e. the parties come to an agreement without going through an exchange or they may be executed through an exchange. Options issued through an exchange usually have a standardized structure. These kinds of options are often referred to as listed options.

Listed options are a forward type of trading instrument i.e. both parties agree to exchange securities at a specific price by a specific date. Because they are forward transactions, listed options are normally traded on a forward exchange.

Types Of Listed Options

There are two main types of options i.e. calls and puts. Both are based on holders having the right to buy or sell while not being obligated to do the same. The writers on the other hand are obligated to buy or sell securities if the holder exercises the contract.

To purchase an options contract, holders have to pay an option premium. This is regardless of whether the option is exercised or not. Let’s take a closer look at the types of options.

Call Options – Holders of call options have the right to buy specific securities at a specific price within a predetermined period. They are based on speculations on price movements in the market. The holder can exercise their options contract when their predictions were correct and prices move in their favor. In such cases, the options bring in a profit. When price movements are not favorable, holders can simply let the contract expire. In such a case all that will be lost is the premium that was initially paid.

Put Options – Holders of put options have the right to sell specific securities at a specific price within a predetermined period. They are also based on speculations on price movements in the market. The holder can exercise their options contract when their predictions are correct and prices move in their favor. In such cases, the options bring in a profit. When price movements are not favorable, holders can simply let the contract expire. In such a case all that will be lost is the premium that was initially paid.

Rights And Obligations In Options

There are usually two parties involved in an options contract i.e. the holder and writer. The options contract usually gives the buyer (holder) rights and the seller (writer) obligations. Let’s take a closer look at the two.

Holder’s Rights – It’s usually the holders (buyers) of a contract that have rights. They have the right to execute the option i.e. to be or sell an option. They also have the right not to exercise the contract i.e. to let the option contract expire.

The type of option is what determines the specific rights that the holder has. When the contract is for a call option, then the owner has the right to buy a specific number of securities at a specific price and within a predetermined timeframe. When the contract is for a put option, the holder has the right to sell a specific number of securities at a specific price, within a predetermined timeframe.

Writer’s Obligations – Options are more one-sided than balanced in that the writers are obligated to buy or sell options if the holders decide to exercise the contract. The obligations that writers have, will be dependent on the type of options used in the contract. For a call option, the writer is obligated to sell a specific number of securities at a specific price, within a predetermined timeframe. For a put option, the writer is obligated to buy a specific number of securities at a specific price and a predetermined price.

Wrapping Up

Listed options are a unique form of trading. They are a means for traders to speculate, hedge, and even buy some time when making some trading decisions. New traders need to understand how options work. Understanding aspects of premiums and factors that affect their prices are essential. Also knowing the language of the options trading market as well as the definitions of terms such as rights and obligations, is important.