Derivatives: introduction to options: traded options
A traded option is a financial instrument that grants the option holder the right, but not the obligation, to buy (i.e. a call option) or sell (i.e. a put option) an asset at an agreed ‘strike’ price within a prescribed period.
A traded option is so called because the option, once issued, can be traded on a securities market i.e. a stock exchange, or alternatively, outside the marketplace between the option holder and a third party (commonly known as an Over the Counter (OTC) transaction).
Being exchange regulated, traded options normally have standardised contract specifications that outline:
- Exactly what the underlying asset is;
- Where and how the underlying asset is to be delivered upon option exercise (if the underlying asset is capable of being delivered);
- How much money the option holder will gain or lose as the open market price of the underlying asset changes; and
- What each party to the option is obliged to do when the contract is exercised.
Traded options, typically, have a standardised life span of three, six or nine months and inevitably involve contracts (see STSM112040) in multiples of 1000 quantity of the underlying asset.
Being listed and tradeable on exchanges, traded option prices are published in the same way as underlying company share trading.
A holder of an equity traded option can:
- Exercise the option anytime prior to its expiry; or
- Allow the traded option to lapse on expiry; or
- Sell the rights to the traded option anytime prior to its expiry.
See STSM112010 for the meaning of ‘strike’ price
See STSM112050 for the meaning of option exercise
See STSM112100 for the meaning of Over the Counter (OTC)