Derivatives - Other Options

Although you have been reading about indexes as the underlying commodity for options, the focus has been on stock indexes in particular - that is, equities have been the underlying commodities of those indexes. In reality, the options market is far bigger and more complex than that.

Debt Options
There are also options on bonds. There are two kinds of listed debt options:

  • Price-based options give their holders the right to purchase or sell a specified underlying debt security. Settlement can take the form of either physical delivery or cash settlement, depending on how the contract was written.

  • Yield-based options are cash-settled based on the difference between the exercise price and the value of an underlying yield.

Look Out!

Price-based options have traded in the past and may be traded in the future but, as of this writing, only yield-based options are listed on the Amex.

Most debt options traded on the Amex are based on U.S. Treasury securities. Other countries issue bonds and certainly have robust debt option markets of their own. Still, when focusing on the U.S. market for purposes of passing the Series 7 exam, the only non-U.S. based options you need to focus on relate to foreign currency.

Foreign Currency Options
The right to purchase or sell one currency at a price denominated in another currency. The price of one currency in terms of another is known as an exchange rate. If the British pound is worth roughly two U.S. dollars, and the exchange rate for the pound is $2; the exchange rate for the dollar is then 0.5 pounds.

  • The exercise price of a currency option is an exchange rate.
  • For example, if your client thinks the pound will continue to appreciate against the dollar, he might buy a pound call with an exercise price of $2.05. On the Amex, foreign currency options are typically, but not always, U.S. dollar-denominated; it is possible, for example, to buy "cross-rate" foreign currency options that take positions on how the euro will move against the yen.
Tax Treatment of Options
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