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Options

There are two types: call option or a put option: 

  1. A call option gives the buyer of the option the right to buy the underlying asset; 
  2. A put option gives the buyer of the option the right to sell the underlying asset. 

The seller of the option is obliged to meet the obligation placed upon them by the buyer: 

  1. The seller of a call option must sell the underlying asset to the option holder; 
  2. The seller of a put option must purchase the underlying asset from the option holder.

The holder of the option can either:

  1. Exercise the option on expiry;
  2. Sell the option before expiry; or 
  3. Let the option expire worthless. 

Within the world of put and call options there are two more types:

  1. An option that can only be exercised at expiry is known as a European-style option. 
  2. One that can be exercised at any time during its life is known as an American-style option.

Questions - Use Your Note Taker To Jot Down Ideas / Calculations

1. James can make the decision as to whether he exercises his right to SELL an underlying asset at a
certain price, at any time during a specified period, he therefore has:

a) a European style put option.

b) an American style call option.

c) a European style call option.

d) an American style put option.

D)

The derivative in question is an option as the individual has the right but not the obligation to sell
the underlying asset. The option is a put option rather than a call option because it gives the right to
sell rather than buy the security. The option is American style because it gives the individual the right
to exercise the option at anytime during a specified term rather than just at the end of the term.

2. Mark has purchased an investment that gives him the right but no obligation to buy some shares at a
fixed price at a set date in the future. He has purchased a[n]:

a) American-style put option.

b) European-style call option.

c) American-style call option.

d) European-style put option.

B)

The derivative is an option because it gives him the right but not obligation to buy the shares. It is a
call option because in options call=buy and put=sell. It is a European style call option as the date on
which the shares can be purchased is fixed.

  • Further study text reading: Pages 307-312