In finance, an options contract will give its holder a right but not an obligation to carry out a specified transaction in accordance with the terms and conditions stipulated by the options contract’s term sheet.
Example: You purchase a call stock option that gives you the right to purchase 100 shares in NYSE: GLT for 20 USD per share on the expiry date of the option, which is December 15 this year.
On December 15, you check the market price for GLT on NYSE and see that it is $25 per share. You exercise (use) your option and buy 100 GLT shares for $20 per share, paying a total of $2,000. You decide to realize your profit, so you immediately sell your 100 share for $25 each, getting a total of $2,500. You have made a $500 profit.
In reality, this step where you first buy the shares and then sell them is usually skipped. Instead, the creator of the options contract (the writer) will simply transfer $500 to you when you elect to exercise the option. Also, exchange-traded options are typically settled through a clearinghouse, which means that the writer of the option and the holder of the option will not even be in contact with each other.
Call options vs put options
In the example above, you owned a call option. It gave you the right to buy the underlying asset. If you instead had purchased a put option, it would have given you the right to sell the underlying asset.
Binary Options
Binary options are not regular options and are not traded on the open market. They do not have any value and can not be sold. The only way to get a return is if they mature in the money. I do not trade with binary options and do not feel qualified to tell you more about them. I recommend that you visit this website if you want to learn more.
Premium & Strike price
The premium is the price you pay when you purchase an options contract.
The strike price is the price you pay (call option) or receive (put option) per unit if you elect to exercise (use) the option and carry out the transaction.
Exercising the option
When you can exercise the option you have purchase depends on the terms stipulated in the options contract’s term sheet.
Some options can be exercised on any day until throughout the lifetime of the option, and these options are known as standard American-style options. Standard European-style options can on the other hand only be exercised on the option’s expiry date.
Exotic options are neither American-style nor European-style. One of the most well-known among the exotic options is the Bermuda-style option, which can only be exercised on certain dates stipulated in the term sheet. The barrier option is another example of an exotic option. A barrier option can only be exercise if the market price of the underlying asset passes a certain point (the barrier point).
Who is my counterpart?
When you purchase an option, the issuer of that option becomes you counterpart. When it come stock options, the issuer is called the writer. If you elect to exercise the option, the writer is the one responsible for making sure that the transaction is carried through. So, if you have a call option that gives you the right to buy 100 common shares in a specific company, the writer is the one who must provide you with these shares or pay you in cash when you elect to exercise the option.
When you exercise an option and get paid in cash instead of actually getting 100 shares, 50 bales of cotton or one thousand barrels of Brent crude oil, your option is being cash-settled. Most options contracts stipulate in the term sheet that the parties are allowed (or mandated) to cash-settle the option instead of actually making or taking delivery of the underlying asset.
If it is important to you that you get to make or take delivery of an asset, you must seek out options where the options contract’s term sheet specifies physical delivery of the underlying asset upon exercise.