OPTIONS INTRODUCTION

In addition to futures, the derivatives markets are also comprised of options contracts – securities which allow the purchaser the right but not the obligation to buy or sell a specific amount of an underlying financial asset or commodity at a fixed price on or before a specific date. In the following section, we’ll explain the dynamics of these highly versatile trading products, how they are priced, and how traders manage the risks associated by options contracts.

Options contracts come in one of two forms:

• Calls: contracts which gives the buyer of the option the right, but not the obligation, to BUY a certain amount of the underlying asset at a fixed price, on or before a set date.
• Puts: contracts which gives the buyer of the option the right, but not the obligation, to SELL a certain amount of the underlying asset at a fixed price, on or before a set date.

Despite their apparent simplicity however, options can be used to express a wide range of market views, from whether prices are going up or down, or whether volatility is set to decrease or increase. Also, buying a call or a put gives you unlimited profit potential while your downside is limited only to the original price paid for the option, known as the premium.