Options Contract(2)
2021.08.29 08:04
Hi It's Unicorn
Exercise
Buyers have rights to choose to exercise the contract according to the situation. When buyers determine right market trend, they usually require to execute the contract and earn the spread, which is called “exercise”. On the contrary, When the buyer determine wrong market trend, they can choose to waive the contract and will lose the premium.
Situation 1: Market Price > Strike Price
Buyers will exercise the contract to make profits and earn the spread, but loss the premium.
Sellers will get the premium but loss in the spread.
Situation 2: Market Price < Strike Price
Buyers will choose to waive the contract and loss the premium.
Sellers will earn the premium as their profits.
As previous example, Cindy wants to buy a limited edition bag. The price of the limited edition bag is $100,000. Cindy is afraid some sellers will speculate in the limited edition bag and make its price get higher after it’s listed on the market. Accordingly, she paid $10,000 as premium to the seller to ensure she can buy it with original price after the bag is listed in the market. If the price of the limited edition bag rises to $150,000 after it is listed on the market, Cindy can buy it at $100,000 according to the contract. If she resells it at the price $150,000, she can earn the profit $40,000. For the seller, they only earn the premium and loss $50,000 in spread. Therefore, the total loss of the seller is $40,000. Conversely, If the price of the limited edition falls to $50,000 after it’s listed, Cindy would rather buy it at market price than the contract price. Accordingly, Cindy choose to waive the contract so she losses the premium $10,000. For the seller, they earn the premium $10,000 without any costs.
We mention it before that there are buyers(owners) and sellers in the option market. They will purchase call option or put option according to the market trend. As the buyer, you can purchase call option or put option according to the market trend. You may earn the profit when the price trend is consistent with the forecast you bought. As the seller, you can sell call option or put option. If the price trend is opposite to the forecast you sold, you can earn the profit.
What will affect the premium?
As previous mention, the premium is paid by the buyer to purchase the right to exercise the contract.
The following are the factors which will affect the premium.
1. Market price: the current market price of underlying asset.
2. Strike price: The price at which the Options Contract.
3. Exercise Time:The time at which the Buyer can exercise their right as stipulated by the Options Contract.
4. Volatility
The spread of market and strike price will affect the premium. For instance, Market price is $10,000 and Strike price is 6,000. The spread is $ 4,000. The seller has the corresponding obligation to fulfill the transaction. If the amount in the spread is a lot, the buyer can earn more profits. Therefore, the buyer has to pay more amount of the premium to attract sellers who are willing to bet against you. It means the buyer has to pay more costs to purchase the options contracts.
In addition, the longer expiry date of the contract means the uncertainty will be higher so the amount of premium will rise. If the volatility of market is high, there are more uncertainties in the market. The amount of premium will rise, either.
Above factors may affect your risk and profit, you need to consider comprehensively.
European options and American options
The difference between European options and American options is the exercise time.
European options: European options: Buyers(owners) can choose whether to exercise their right to buy or sell only while the the contract expires.
American options: Buyers(owners) can request to exercise the options contract at any time up to the exercise time.
