Types of Options
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There are various types of options available in the market which can be categorized in a number of ways. Call options and put options are the two most important and popular categories of options which are well known among the market players.
Except for these two types, the other includes American and Europeans style options. These two types of options have nothing to do with the geographical area but, they are different in the date of expiry.
On an overall basis, there are multiple types of derivatives too. But, we will discuss that some other day!
Types of Options in Stock Market
Some other types of options include:
- Exchange-traded options,
- Over the counter options (OTC),
- On the basis of types of security,
- Option type by date of expiry,
- Cash-settled options,
- Employee stock options,
- Exotic options etc.
Here we are going to discuss all the above types of options one by one.
Standard Types of Option
As mentioned above, there are various kinds of options available for traders. Each of these options varies in one respect or the other. You have to see what your preferences are.
Here are the details:
Call option refers to the contract which gives the holder the right to buy an underlying security at an agreed price in the future. An investor buys a call option when he/she believes that the price of the stock is likely to increase in the future.
You, as a trader, are bullish towards the market in such an option type.
There are three different situations which are likely to be experienced by the holder of the call option i.e
- In- the money (stock price > strike price),
- At-the-money (stock price=strike price),
- Out of the money (stock price<strike price)
where the strike price is the price agreed upon during the contract set-up.
A put option is just the opposite of call options.
The trader whoever is holding the put option has the right to sell the underlying security at a fixed price in the future. An investor buys a put option when they believe that the price of the stock is likely to decrease in the future.
There are three situations which are likely to be experienced by the put option holder, including:
- In-the-money (Strike price>stock price),
- At-the-money (Strike price=stock price) and
- Out of the money (strike price<stock price).
In Put Options type, your expectation towards the market is bearish in nature.
American Style Option:
This type of option has nothing to do with the geographical area. Normally, the option contract comes with an options expiration date, at which date the holder has to exercise their right to buy (if call) or sell (if put).
But, in the American style option type, the holder can buy or sell the underlying security before any time of expiry date.
This is an additional advantage to the holder of the American style option holders where the expiry date is not to be mandatorily followed by the holder.
Obviously, the option seller has an added risk in this option type.
European Style Option:
European style option holder can not enjoy the same advantage as the holder of the American style option holder. If you are the holder of this style option, then you can exercise your right to buy or sell only on the date of expiration not before.
Except this, there is no difference between the American style option and the European style option.
Since there are limitations involved, this type of option is lighter on your pocket as compared to other option types. This reduced extrinsic value of the contract improves your monetary profit as well.
An exchange-traded option is a standardized form of option which is also known as the listed option. Any option contract which is listed on a public traded exchange comes under exchange-traded option.
This type of option is the most common among the options traders. It can be traded by anyone.
Over the Counter Option (OTC):
Options contracts which are traded in the OTC market come under this category. It is not like an exchange-traded option and is less accessible to the general people i.e. retail traders.
As option under this category is traded by two private parties and customized according to the needs of those two parties. An OTC option is also known as ‘dealer options’.
Types of Options Based on Underlying Securities:
The stock option is very common among people. Mostly, Whenever we talk about an option contract, publicly traded shares come into our mind. Fewer people have an idea that there are other types of underlying securities also available in the market.
Here we are going to discuss very common types of underlying securities.
Stock option: This is a very common type of options contract in which the underlying asset is the publicly traded shares of a company.
Index option: It is similar to the stock option. But the difference is that here underlying asset is the index like bank nifty, nifty, S&P 500 etc. instead of shares of a publicly listed company.
Currency/Forex options: Here underlying asset is the specific currency which gives the holder of the options right to buy or sell at a fixed exchange rate.
Commodity options: In commodity options, the underlying asset is either a commodity futures contract or physical commodity.
Futures options: In future options, the holder of the contract has the right to enter into the specified future contracts with a fixed price at any time before the expiry of the contract.
Basket options: Basket options contract is based on the group of underlying securities. That basket or group could be made up of currency, stocks, commodities or other financial instruments.
Types of Options Based on Expiration Cycle:
Options contracts can be classified on the basis of their expiration cycle also. Some option contracts are available with only one type of expiration cycle, while the other has options to choose the expiration cycle.
Here are some of the option type by its expiration cycle.
Regular options: This is a standard expiration cycle. You will get options for four different months of expiration while purchasing this type of options contract. Here, you will be able to choose expiry months of contract from four different months based on your preference.
Weekly options: This type of contract is as same as regular options, but the difference is that its expiry period is much shorter than the regular option. Currently, weekly options are available for limited underlying securities and some major indices.
Long-term expiration anticipation securities (LEAPS): This is a long-term contract which always expires in the month of January. As it is longer-term options, it lasts from one year to three years before expiry. Leaps are available in two forms i.e calls and puts.
Other Types of Options
There are a few other types of options as well that you must be aware of. These options types come with their own provisions and trader benefits:
This is a different type of option.
Normally what happens is that the holder of an option contract either buys or sells the underlying security on the expiration of the contract.
But, in cash-settled option, the way of the settlement is different. Here, the contract is not settled by the transfer of underlying securities.
The contract is settled only through cash. The writer of the contract pays profit in cash to the holder of the security. Due to this, cash-settled options are used when the underlying security is either difficult or costly to transfer.
Employee stock options:
In this type of options plan, a company gives its employees the right to buy a fixed number of shares of the company at a fixed price within a specified period.
This plan is highly being used by both public and private companies to attract, retain and compensate their employees.
Employee stock option is different from those options which are bought and sold by the traders on a stock exchange.
As this option plan gives employees the right to buy, so these are mainly in the form of the Call option, which can be exercised in the future at a fixed strike price.
This option has more complex features than normally traded options. Exotic options are normally traded in the OTC market instead of any stock exchange. It comes under non-standardized options and has been customized.
Nowadays, due to the popularity among investors, some of the Exotic options are also getting listed on the exchanges. Binary options, barrier options, compound options, chooser options are some of the types of exotic options.
Here is a quick summary of this detailed review of the types of options:
- Different types of options are available in the market, which can be categorized in different ways.
- Calls and puts are the two most popular types of options.
- On the basis of styles, there are two types of options, one is American and other is European style options.
- Stock traded options and the OTC market options are opposite to each other. As OTC market options are less accessible to general people.
- Options types by expiration are classified on the basis of the different expiration cycle and option type by underlying security is classified on the basis of different types of underlying assets.
- Cash-settled options are different from standard options, as it is settled only in cash.
- Employee stock options are different from the options traded on exchanges. Most of the private and public companies offer this option type to their employees as remuneration, bonus or to attract them.
- Exotic options are non-standardized and customized features options.
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