Page 68 - DCOM510_FINANCIAL_DERIVATIVES

Unit 5: Introduction to Options

Self Assessment Notes

Fill in the blanks:
1. Options can be divided into two types: ……………….. and ………………..
2. A ……………….. option can be exercised on the expiration date only whereas an
……………….. option can be exercised at any time before the maturity date.
3. The options that are currently traded in the market are …………………… options and
……………….. options on the 30 stocks.

5.2 Option Terminology

The following are the key terms used in options:
1. Buyer of an option: The option buyer is the person who acquires the rights conveyed by
the option: the right to purchase the underlying futures contract if the option is a call or the
right to sell the underlying futures contract if the option is a put.

Did u know? The buyer of an option is the one who by paying the option premium, buys
the right but not the obligation to exercise his option on the seller/writer.

2. Writer of an option: The option seller (also known as the option writer or option grantor)
is the party that conveys the option rights to the option buyer. In other words, the writer
of a call/put option is the one who receives the option premium and is thereby obliged to
sell/buy the asset if the buyer exercises on him.
3. Option Class: All calls and puts on a given underlying security or index represent an
“option class.” In other words, all calls and puts on XYZ stock are one class of options,
while all calls and puts on ZYX index are another class.

4. Option Series: All options of a given type (calls or puts) with the same strike price and
expiration date are classified as an “option series.”

Example: All XYZ June 110 calls would be an individual series, while all XYZ June
110 puts would be another series.

5. Contract Size of Equity Options: The contract size of an option refers to the amount of the
underlying asset covered by the options contract. For each unadjusted equity call or put
option, 100 shares of stock (usually, but this may differ from stocks to stocks) will change
hands when one contract is exercised by its owner. These 100 shares of underlying stock
are also referred to as the contract’s “unit of trade.”
6. Contract Size of Index Options: The contract size of a cash-settled index option is
determined by its multiplier. The multiplier determines the aggregate value of each point
of the difference between the exercise price of the option and the exercise settlement value
of the underlying interest.

Example: A multiplier of 100 means that for each point by which a cash-settled
option is in the money upon exercise, there is a $100 increase in the cash settlement
amount.
7. Option price: Option price is the price which the option buyer pays to the option seller. It
is also referred to as the option premium.

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