What you need to know before writing an option contract
An option contract is a document that gives the right to purchase or sell a specific asset at a specified value and within a specified date. In this case, the subject of the auction is not the asset itself, but the right to sell or buy it. An option relates to securities and is considered a legally valid contract. There are several types of such document:
- types. There are call and put options;
- by asset type. In this case, operations with futures, various commodities or currency, also with shares of companies can be conducted;
- styles: European, Asian or American options;
- method of settlement: with or without the payment of the premium.
The Call option contract allows you to acquire an asset at a fixed cost over a specific period of time. This principle is similar to the long position principle that applies to shares. The contract is also called an option made to buy.
Thanks to Put, it is possible to dispose of an asset for a specified value within a specified period of time. It is reminiscent of the short position taken when dealing with shares.
It should be noted that the contract is not mandatory for use, its owner may not carry out the purchase or sale of the asset within a clear period of time.
The base asset affects the type of contract. A commodity allows you to buy/sell goods in a specified quantity at the option price, which must be used before the specified period.
The stock contract allows for transactions with ordinary shares of the company. With a currency option, the owner has the right to buy or sell the currency at a fixed value within a fixed period.
A futures option contract will allow you to buy or sell it in a certain month, when it will be delivered and with a specific asset.
Contracts have different styles. The US assumes that these contracts can be used any day before the end of the term.
With a European style document, the sale or purchase of an asset can only be carried out after a certain period of time. The execution date of the contract is usually specified in the terms and conditions.
The option, which refers to the Asian style, requires execution at an average price, which is calculated based on the data for the period while the document is valid.
In most cases, American-style option contracts are used to operate on an exchange, while European and Asian-style documents are non-exchange.
According to the differences in the type of settlement, options are divided into those with and without a premium. The former assumes a premium to the holder on the same day that the transaction was concluded.
Options that are exercised on an exchange must have a specification, which includes the requirements of a particular trading floor. Off-exchange options do not follow strict standardization, they can be prepared as convenient for participants.