OPTION

An option is a contract, or a provision of a contract, that gives one party (the option holder) the right, but not the obligation, to perform a specified transaction with another party (the option issuer or option writer) according to specified terms. The owner of a property might sell another party an option to purchase the property any time during the next three months at a specified price.

Option contracts are a form of derivative instrument. Stand-alone options trade on exchanges or OTC.

Options take many forms. The two most common are:

call options, which provide the holder the right to purchase an underlier at a specified price;

put options, which provide the holder the right to sell an underlier at a specified price.

The strike price of a call (put) option is the contractual price at which the underlier will be purchased (sold) in the event that the option is exercised. The last date on which an option can be exercised is called the expiration date. Options may allow for one of two forms of exercise:

With American exercise, the option can be exercised at any time up to the expiration date.

With European exercise, the option can be exercised only on the expiration date.

 

A third form of exercise, which is occasionally used with OTC options, is Bermudan exercise. A Bermuda option can be exercised on a few specific dates prior to expiration. Yes, the name was chosen because Bermuda is half way between America and Europe.