Equity and Index Options Explained

2

Option Specifications

Before going into detail, an important preliminary distinction needs to be made. Options that are traded on a recognised exchange, such as LIFFE or the CME, are known as exchange traded options, abbreviated to ETOs. Any trading that takes place away from a recognised exchange is “over-the-counter”, abbreviated to OTC. It is likely that most readers of this book will confine themselves to ETOs for reasons of convenience, simplicity and capital efficiency. Nonetheless, the vast majority of what follows applies generically, to all types of options, unless otherwise stated.

All options are specified exactly in respect of the following:

• Whether it is a call or a put
• The underlying
• Strike price
• Expiry date
• Exercise rights

Let's consider each of these factors individually.

The first point has already been covered; any option that conveys the right to buy something is a call. Any option that conveys the right to sell something is a put.

The underlying (sometimes known (esp. USA) as the “underlier”) can be just about anything, as long as it has a price. In the OTC markets, there are options on an astonishing range of underlying assets, from obvious candidates such as currencies, interest rates, bonds, equities, indices and the like, right through to more unusual underliers such as emissions, satellite loadk-space and the weather.

The point has already been made that the majority of readers of this book are likely to stick to ETOs, and with respect to ETOs (see ...