Following are the terminologies of options:
1. Stock Options: Stock options are options on individual stocks. A contract gives the holder the right to buy or sell shares at the specified price.
2. Index Options: These options have the index as the underlying. Some options are European, while others are American.
Like index futures contracts, index options contracts are also cash-settled.
3. Buyer of an Option: The buyer of an option is the one who, by paying the option premium, buys the right but not the obligation to exercise his option on the seller/writer.
4. Writer of an Option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.
5. Expiration Date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date, or the maturity.
6. Strike Price: The price specified in the options contract is known as the strike price or the exercise price.
7. Option Price/Premium: Option price is the price that the option buyer pays to the option seller.
It is also referred to as the optional premium.
The option premium is classified into two types:
i. Call Option Premium: The premium on-call option represents the cost of having the right to buy the underlying currency at a specified price.
For MNCs that use currency call options to hedge, the premium reflects a cost of insurance or protection to the MNCs.
ii. Put Option Premium: The put option premium (referred to as P) is primarily influenced by three factors:
- S – X represents the difference between the spot exchange rate (S) and the strike or exercise price (X),
- T represents the time to maturity, and
- σ represents the volatility of the currency, as measured by the standard deviation of the movements in the currency.
8. Exercising the Option: Exercising is using this right the option grants you to buy or sell the underlying asset.
The seller may have a potential commitment to buy or sell the asset if the buyer exercises his right on the option.
9. Exercise Price: The exercise price is also called the fixed price, strike price, or just the strike and is determined at the beginning of the transaction.
It is the fixed price at which the holder of the call or put can buy or sell the underlying asset.