Description of Options Markets and Contracts
By Adam Milton. Day Trading Expert
Option markets are similar to futures markets, in that they give the holder the right to buy or sell the underlying commodity for a specific price on (European options ) or before (US options ) a specific date in the future (known as the expiration or exercise date), but options have some significant difference from futures, and are traded quite differently.
Right or Obligation
The buyer of the options contract can choose whether or not to exercise their right, and if they do, the seller of a matching options contract will be obligated to complete the transaction. The seller to complete the transaction is chosen by the options clearing system, which is the Options Clearing Corporation in the US, and Clearstream Banking (a division of the DTB exchange) in Europe.
Options markets include European style options like the following:
- ODAX - Cash settled options based upon the DAX stock index of the DTB (Deutsche Boerse) in Europe
- OSMI - Cash settled options based upon the SMI stock index of the SWX (Swiss Exchange) in Europe
- ESX - Cash settled options based upon the FTSE100 stock index of Euronext (LIFFE) in Europe
and US style options like the following:
- EUR - Futures settled options based upon the EUR futures of Globex (Chicago Mercantile Exchange) in the US
- OYM - Cash settled options based upon the YM Dow Jones stock index of ECBOT (Chicago Board of Trade) in the US
- OZG - Futures settled options based upon the ZG Gold 100 Troy Ounce futures of ECBOT (Chicago Board of Trade) in the US
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Options markets trade options contracts, which specify the underlying security, the expiration date, and the strike (or exercise) price. Day traders can trade options contracts to make a profit on the difference between the buying price and the selling price (when
the options are sold before expiration), or to make a profit from the underlying security when they are exercised.
As with futures contracts, options contracts are traded by day traders and longer term traders, and also by non traders with an interest in the underlying commodity. When traded for the underlying commodity, options contracts work the same way as futures contracts, but only give the right to buy or sell the underlying commodity rather than the obligation.
Futures or Cash Settlement
Both European and US style options are settled in either cash or a futures contract in the underlying security when they are exercised. In the money (in profit), cash settled options, are valued using the trading price of the underlying security at expiration, and the profit is realized into the trader's account. In the money, futures settled options, are converted into the appropriate futures contract, which the trader can then buy or sell to realize the profit.
US traders should note that the SEC (the US securities and exchange commission) has placed restrictions on cash settled options, so not all options markets are available to US traders.
Symbols and Tick Values
The trading symbol for options markets consists of the underlying, the expiration date, whether the contract is a Call (right to buy) or a Put (right to sell) and the strike (or exercise) price. For example, the DAX Call option that expires in December 2007 with a strike price of 7000 would have the symbol ODAX-Call-200712-7000. The contract specifications for options markets include the minimum price change (known as the tick size), and the point value or multiplier, with which the value per minimum price change can be calculated. Continuing with the previous example, the tick size for the ODAX is 0.1, and the multiplier is 5 EUR, so the value per tick is calculated as 0.1 X 5 EUR = 0.50 EUR per tick. This means that for every 0.1 in price change, an option's profit or loss would change by 0.5 EUR.Source: daytrading.about.com