Call and Put options
An options is a financial product that gives the trader the right, but not the obligation, to buy or sell a particular underlying asset (e.g., Crypto coin) at a specified price (the strike price) by a set future time (expiry date). There are two kinds of options, calls and puts.
A Call options or Calls allows the trader to lock in the strike price (buy price) at which to buy the asset by the expiry date.
A Put options or Puts allows the trader to lock in the strike price (sell price) of the asset by the expiry date.
In each type of options, the investor can choose to buy or sell the options.
You buy Calls when you think the underlying asset may increase in price, and you buy Puts when you think the underlying asset may decrease in price.
Options also have an expiration date on which you decide if you want to exercise your option or not. The seller is responsible for exercising those rights for the buyer.
Options can have different strike prices and different expiration dates. As a result, options provide traders with much better hedging and liquidity solutions.
- Buy Call Options
People buy call options when they think the price will increase in the future.
The buyer will lose a premium (which acts as a deposit for the option seller).
If the market goes up, investors can have infinite profits.
If the market goes down, the investor will suffer the biggest loss with only the Premium amount spent.
- Buy Put Options
If you think the price will fall in the future, you can buy a put options for a premium.
If the price falls, you will have a big profit.
If the price rises, you can lose, but the biggest loss is equal to the Premium you paid.
- Sell Call Options
If you think the price will fall, you can also sell the call to get a profit from the premium.
However, when the price rises, you can experience infinite losses.
- Sell Put Options
If you think the price will rise, you can sell the put to receive a premium from the buyer.
However, your risk will be large because the entire collateral amount (equivalent to the breakeven value) of the underlying asset is locked to the transaction. This is to ensure that you can afford to buy back the underlying asset when its price falls below the breakeven price on the expiration date of the sold-put options.
Some terms
Orderbook
A list of orders on a particular asset reflecting all the orders from the different buyers and sellers open in a market. It effectively shows the price and volume that participants are willing to buy/sell the asset for.
Call Options
Gives the buyer the right (but not obligation) to purchase an asset at the particular price and date specified in the contract.
Put Options
Gives the buyer the right (but not obligation) to sell an asset at the particular price and date specified in the contract.
Premium
Is the market price of purchasing an options. By paying the premium you purchase the right to exercise an options. The seller receives this premium as their payoff for selling the options.
PnL
Profit and Loss. It represents the change in the value of a trader’s position. Whilst a trade is still open PnL is considered “unrealised” and when the trade is close it becomes “realised” PnL.
Exercising an Option
The event in which the buyer of an options choses to execute the options contract they purchased in order to buy or sell the underlying at the strike price.
Settlement
Occurs when an options is exercised. In the case of physical settlement, there is a transfer of assets between the seller and buyer of an options to reflect the contract that was exercised. In the case of cash settlement, the trader exercising the options is paid out in cash (no exchange of assets) based on their PnL.
Naked Option
Shorting an option without holding any (or enough) of the underlying asset to protect from adverse price movements, exposing the trader to high amounts of unhedged risk.
Collateral
An asset accepted as security for a loan or credit risk. In the case of options collateral is required to make sure that the trader can cover their position if they get margin called.
Spot Price – SS
Is the current market price of the underlying asset.
Strike Price – KK
The price defined in an option contract specifying the price that the underlying asset will be bought/sold at.
Expiry Time,TT
The date specified in the option contract at which the option can be exercised (European options) or that time before which options must be exercised (American options).
Risk-free Rate of Return – rr
The theoretical rate of return on an investment that carries no risk.
Volatility,\sigmaσ
Reflects the extent to which the underlying asset is expected to fluctuate between now and the asset expiry.
Mark Price, V_{mark}Vmark
The last price at which the option was purchased/sold on the market.
Index Price, V_{index}Vindex
The price of the underlying asset, where this price is derived from more than 1 source.
See also: Basic knowledge of options
