Option
1. A financial option is a derivative instrument giving the holder the right - but not the obligation - to buy or sell an underlying asset on or before a future date at a specified price.
Options are more commonly ‘cash settled’ by paying or receiving a net cash amount, rather than being settled by physical delivery of the underlying asset.
Like other derivative instruments, options can be used to:
• Speculate by creating new exposures to market rates.
• Hedge existing exposures to changes in market rates.
• Arbitrage in combination with other related instruments to achieve 'risk free' profits.
When used for hedging purposes, options generally provide insurance-like protection against worst case outcomes. (Contrasted with 'fixing' hedging instruments - such as FRAs - which effectively fix the market rate being hedged.)
2. More generally, choice.
3. A real option is an option relating to an operational decision or outcome.
See also
- American-style option
- Binomial option pricing model
- Black Scholes option pricing model
- Call option
- Cash settlement
- Delta
- Derivative instrument
- European-style option
- Exercise
- Exotic option
- Fixing
- Fixing instrument
- Hedging
- Insurance
- Interest rate guarantee
- Interest rate option
- Payoff
- Put option
- Put-call parity theory
- Real option
- Straddle
- Strike price
- Swaption
- Traded option
- Underlying asset
- Underlying price
- Warrant
