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.)
More generally, choice.
A real option is an option relating to an operational decision or outcome.
- American-style option
- Binomial option pricing model
- Black Scholes option pricing model
- Call option
- Cash settlement
- Derivative instrument
- European-style option
- Exotic option
- Fixing instrument
- Foreign exchange forward contract
- Interest rate guarantee
- Interest rate option
- Put option
- Put-call parity theory
- Real option
- Strike price
- Traded option
- Underlying asset
- Underlying price
- Volatility index