In general terms, an option is a right or obligation to buy or sell a good at a price and date established at the beginning of an operation. This right or obligation to buy or sell is obtained by paying a premium to the person who takes the obligation.
There are two basic types of options:
a) Call option gives its owner the right to buy an asset on a certain date and at a certain price.
b) And, the put option that gives the owner the right to sell an asset on a given date at a certain price.
To better understand the difference between these two types of option payments, see Table No.11.
Table No. 11: Payment structure
"Whatever its mechanism, an option will be a call when its holder wins if the underlying raises, and a put when its holder wins if the underlying falls." (Rodríguez, 1997).
Another form of distinction of the options is determined by the dates in which it is allowed to exercise the rights that the option grants, and they are known as American or European options and it has nothing to do with their geographical location.
The American type option is one that is exercised only on its expiration date.
And, the European option is the one that can be exercised on any date until its expiration date.
Most of the options traded in international markets are American, since these are generally more valuable than European ones, since they grant more rights.
Options can be on stocks, currencies, indices, commodities, etc.
But, the most important form of options is on futures, case, which will be explained below.
Options on futures
In order to hedge with this type of instrument, it offers some advantages, since it avoids having the capital to face margin deposits, since only the premium payment is required at the beginning of the operation.
Options on futures are "convenient for those who do not have sufficient capital to trade futures and to protect positions acquired in the futures market." (Rodríguez, 1997).
In this type of financial instrument, the future normally expires shortly after the share expires.
Two cases can happen:
1) “When the owner of a call option exercises it, he acquires from the issuer a long position in the underlying futures contract plus an amount in cash equal to the excess of the future price over the exercise price.
2) When the owner of a put option exercises it, he acquires a short position in the underlying futures contract plus an amount in cash equal to the excess of the exercise price above the future price ”. (Hull, 1996).
In other words, the payment of an option on futures is equal to the payment of an option on shares with the price of the share replaced by the price of the future.
Normally these types of contracts are used on long-term Eurodollars and Treasury bonds.
Bibliography
RODRÍGUEZ, by Castro J. (1997). Introduction to Analysis of Financial Derivative Products. 2nd Edition, Editorial Limusa, México.
FRAGOSO, JC (2002). "Analysis and Administration of Financial Risks". Exposure of the subject of Risk Analysis, of the specialty in Financial Economics of the Veracruzana University, Chapter 13: Derivatives Market, Xalapa, Ver.
HULL, John (1996). Introduction to Futures and Options Markets. Editorial Prentice Hall, Spain.
