Option

An option is a contract which gives the holder the right to buy or sell an asset by a certain date for an agreed price.

Unlike forward contracts, the options are rights and not obligations. The agreed price is called exercise price (or strike price or simply strike), the date is called expiry date (or exercise date or maturity). And, the asset is called underlying asset (referring to the option on an asset, for example, if option is on American dollars then underlying asset is American dollars).

Types of Options
There are two types of options:

  1. Call Option
  2. Put Option

Call Option
A call option is a contract which gives the holder the right to buy the underlying asset by a certain date for an agreed price.

Put Option
A put option is a contract which gives the holder the right to sell the underlying asset by a certain date for an agreed price.

Styles of Options
There are two styles of options:

  1. European Style Option
  2. American Style Option

European Style Option
A European style option can only be exercised on expiry date.

American Style Option
An American style option can be exercised at any time up to the expiry date.

NOTE:
If Mr. ABC holds a call option, it is the right of Mr. ABC whether to use his option or not, but the seller of the option (also called writer) is bound to sell the underlying asset.

Similarly, if Mr. ABC holds a put option, it is the right of Mr. ABC whether to use his option or not, but the buyer of the option is bound to buy the underlying asset.