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On modern exchanges, investors buy and sell far from just shares, currency or some goods, such as oil or gold. There are also so-called derivatives - these include, for example, futures and options. How futures work we recently reviewed in our blog, and today we will talk about options.
Note : any investment activity on the exchange is associated with a certain risk, this must be taken into account. To carry out operations with the assets referred to in this topic, you need a brokerage account, you can open it online . You can debug your trading strategy using test access with virtual money .
How options appeared
As in the case of futures, options came into circulation due to the fact that farmers needed to protect themselves from losses due to crop failures, and resellers of goods could save money with the help of contracts that set the price of assets in the future (in case of luck) .
People have entered into such contracts for millennia. For example, Aristotle described an example of successful speculation carried out by another philosopher - Thales, who predicted a high yield of olives next summer. With this fact in mind, he rented presses for squeezing oil in two cities for the future period in advance at a low price. The press owners were pleased with this deal - they did not know whether they would be able to load their capacities. The bet was played - the harvest was rich, Thales resold the right to use the press with good profit.
This story is widely described in the literature, although some researchers question it. In any case, such transactions correspond to the modern concept of a put option (we will talk about the types of options later).
There are references to such contracts in the Bible: according to the plot, Laban offered Jacob the right to marry his youngest daughter Rachel in exchange for seven years of service. This example illustrates the risk that option traders faced in the early stages of the development of this financial instrument - the likelihood of failure to fulfill obligations of one of the parties. As you know, after 7 years, Laban refused to marry Rachel for Jacob, asking him to marry his other daughter.
With the development of trade and humanity as a whole, exchanges and speculation arose. Already in the Middle Ages, trading floors existed in different parts of the world. For example, in Europe, the stock exchange in Antwerp was popular, and in Japan, the rice exchange in Osaka successfully functioned.
One of the most striking examples of the use of derivatives such as futures and options is the period of “tulip mania” in the Netherlands, which occurred in the 1630s. Then, for several reasons, the demand for tulip bulbs significantly exceeded supply (we wrote in detail about this story here ).
Accordingly, deals with such a valuable asset at that time were popular. On an exchange in Amsterdam, traders entered into contracts for the purchase and sale of onions with a future settlement date at a predetermined price. In the case of an option, upon the agreed date, the buyer / seller could exercise his right to buy or sell tulips at the price agreed upon earlier. If it was profitable - he exercised the right, if the market conditions changed and such a price became unprofitable - no action could be taken.
Centralized sites for the trader in option contracts appeared much later. For example, in the 20s of the 19th century, such transactions appeared on the London Stock Exchange, and the real dawn of this type of investment happened already in the 1970s after the launch of the Chicago CBOE options exchange.
How options work now
After hundreds of years of evolution of options, such contracts have come to a certain form. Today, an option means the right to buy or sell a specific asset (underlying asset) in the future at an agreed price. Everything is similar to futures, only there the parties are obliged to conduct transactions on the agreed terms, while the option is a right.
As the underlying asset, options usually use the same assets as for futures. In addition, the futures themselves may be the underlying asset of the option.
That is, the buyer of the option acquires the right to buy or sell the asset upon the agreed date (option expiration). Whether or not to exercise this right is his choice, but if he decides to exercise it, the option seller can no longer refuse the transaction. By the way they are exercised, options are divided into American and European. American can be executed at any time before the date of expiration, and European only strictly on this date.
Derivatives are traded on the same exchanges as ordinary stocks and other assets. In Russia, the derivatives market for the derivatives market is the derivatives market of the Moscow Exchange. There are speculations with futures and options.
Like futures, options are traded on the stock exchange - usually in the same sections (on the Moscow Exchange this is a derivatives market).
How it works in practice
Since options have quite a few different parameters, for convenience of operations in the trading software they usually have a separate window for them - this is an options board.
Option board in SMARTx terminal
We have developed a series of plug-ins for the terminal that will be useful when trading option contracts. With their help, you can not only conduct transactions, but also build “glasses”, volatility charts and a market profile, exported data to Excel for further analysis (including dynamic export available).
There are two types of options - call (call) and put (put). Buyers (holders) of call type options are entitled to buy the underlying asset at a strike price on the date of expiration. The sellers of such options transfer the right to make a deal to the buyer. For this they receive an optional bonus. If the buyer ultimately wants to exercise his right, the seller will have to transfer the underlying asset to him and receive money for him.
With put options everything is exactly the same, only the buyer gets the right to sell the underlying asset that he has. Upon the expiration date, he will decide whether to sell or not, and the other party (option seller) will be required to accept the asset and pay for it.
The guarantee that both parties will fulfill their obligations under the transaction is the stock exchange. To do this, there is a guarantee guarantee mechanism - until the transaction is completed, deposits are blocked on the seller and buyer accounts, which will be enough to fulfill the agreed conditions.
A real example of the use of options
One can understand how profitable or disadvantageous / risky an option contract can be with a simple example. Suppose a certain investor wants to conclude an option contract for a period of six months, such as a put to sell 200 shares of a certain company at 200 rubles apiece. At the same time, the current value of this asset is 220 rubles.
Why all this may be necessary for the parties to the transaction? Obviously, the seller of the option hopes that the price of the shares participating in the transaction will not fall below 200 rubles. The buyer expects a fall - and the more, the better for him as part of the transaction.
The seller of an option in this format has higher risks - because if the shares fall below 200 rubles, he will still have to buy them at this fixed price. The buyer of the option option also needs this - he will buy cheap shares on the market and sell them at a higher price, and the other side of the transaction will no longer be able to refuse it.
Why all this is needed
Options have different uses. Of course, this tool is used by speculators who want to earn money. But still, such contracts are also used to hedge risks. It is impossible to completely reduce the risk to zero, but options allow you to make it predictable - the investor knows in advance that if things go wrong, he will only lose the option price.
Useful links on the topic of investment and stock trading:
- Open a brokerage account online
- Test account with virtual money
- Software for trading on the exchange: trading terminal, mobile applications
- Structural Products
- Model Portfolios
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