According to Options Clearing Corporation (OCC- www.theocc.com ) the world’s largest equity derivatives clearing organisation, achieved in 2020, clears record 7,52billion total contracts and 7,47billion options contracts. A total volume up 71% from a year ago and a rise more than 50% from 2019.
What is an option contract
An option is a contract between two investors in which one investor grants the other investor the right to buy (or sell) a specific asset at a specific price within a specific time period. The price of an option is known as a premium. The option contracts and generally the derivatives are used by portfolio managers for hedging strategies – insurance strategies to unexpected turns of the market which could harm their portfolios.
by Thanos S. Chonthrogiannis
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But much of the today’s surge in demand for options comes from small investors who are seeking long-odds bets on single stocks.
The options are rights (as we define them above) that carry no obligation. A financial option is the right to buy or sell an asset i.e., a stock index-at a specified price (the exercise price or strike price) on or before a specified maturity date.
Call options are named the contracts that gives the buyer the right to buy a specific number of shares of a company from the option writer at a specific purchase price during a specific period. If the price of the underlying asset rises above the strike price, then the call options are profitable (the profit is the difference between the current asset price and the strike price).
Put options are rights to sell; they pay off when the price of the underlying asset falls. The option owner is not obliged to exercise the option; He can do that only if it is “in the money”.
The dynamic parameters that affect the price of an option contract is the following:
1. The expected volatility of the price of underlying asset.
2. The expiration time.
3. The current and the strike price.
Option contracts with exercise prices close to prevailing prices cost more.
“Out-of-the-money” are called these options which the strike price has a distance from the actual price. The greater the distance between them the cheaper they are.
Options with a more distant maturity are more expensive than near-dated options. The key variable is volatility. For a small premium a call option can pay a lot of money if the stock price suddenly surges. If not, the option expires worthless.
The hedgers use the options for hedging. One hedge strategy (simple) for a call option is to own the stock, which is why long-only equity funds are increasingly being drawn into the market to juice up their returns.
Also, you could balance the risk from an expensive-looking option-with, say, a round number strike price of the kind favoured by retail investors.
Today, the small investors have easy access to financial markets. So, everybody can be an option trader today.
