Chapter 3: A Brief Analytical Exposition of Markets for Options

A financial derivative that takes the form of a contract between a buyer and a seller providing the buyer the right but not the obligation to buy or sell an asset on or before the expiry date at the contracted price, referred to as the strike price or exercise price, is known as an option. It represents a claim for an underlying asset where the price of the asset is the subject of the claim. In exchange of writing the contract the price received by the seller is called the premium of the option.

The purpose of this chapter is to furnish a brief analytical exposition of different types of exchange-traded options, their usefulness and payoff and profit functions associated with them. There is no obligation on the part of the buyer to exercise the right. So, one choice for the buyer is to allow the contract to expire. The non-obligatory right component of an option on the part of the buyer makes it different from forward and futures undertakings at the basic level. While a forward contract is an off exchange-traded obligatory contract between a buyer and a seller, to buy or sell an asset at a prearranged future time, at a prefixed delivery price; a futures contract is an obligatory exchange-traded contract between a buyer and a seller to buy or sell an asset at a predetermined delivery price during a specified time period in the future.