What are options?

Basic understanding of options is critical to interact with our code seamlessly.

Options are a well-known kind of derivative in traditional finance, and they represent a commitment (of the seller) and an opportunity (for the buyer) to either buy or sell the underlying asset upon expiration, depending on the contract they hold. The contract is issued by the seller and, unlike futures, it represents a right, but not an obligation, of the buyer to exercise the contract terms if s/he wants to.

The concept of a contract that allows the buyer to hold a right that is not an obligation is the most basic and inherent feature of every options contract. Besides that, there are different types of options, types of exercising rules, and types of settlement that can be tweaked to get your best option.

Options types and flavors

There are two types of options: calls and puts.

A call option allow the holder to buy the underlying asset, at the strike price.

A put option allow the holder to sell the underlying asset, at the strike price.

Another important characteristic of options regards the rules to exercise the contract. Options can be either American or European options. An American option is a “continuous time instrument” because it allows the buyer to exercise it at any moment until expiry. A European option is a “point in time instrument,” since it allows the buyer to exercise only when the expiration is reached. Pods options are American; therefore, they can be exercised at any moment until maturity.

An option can be exercised in two ways: cash or physical settlement. Cash settlement assumes that only the difference between the counterparts should be offset, which also means that the margin required for the contract to be valid could be smaller. On the other hand, physical settlement assumes that all the collateral or margin held in custody will be exercised.