We’ve already talked about the differences between calls and puts, but there exist some other ways of categorizing options contracts. American options can be exercised at any time between the date of purchase and the expiration date. The example about Cory's Tequila Co. is an example of the use of an American option. Most exchange-traded options are of this type. European options are different from American options in that they can only be exercised at the end of their lives on their expiration date. The distinction between American and European options has nothing to do with geographic location, only with early-exercise. Most options on stock indices are of the European type. Because the right to exercise early has some value, an American option typically carries a higher premium than an otherwise identical European option.
American and European Options
Options can also be categorized by their duration until expiration. Short-term options are those that expire generally in a year or less. Long-term options with expirations greater than a year are classified as long-term equity anticipation securities, or LEAPs. By providing opportunities to control and manage risk or even to speculate, LEAPS are virtually identical to regular options. LEAPS, however, provide these opportunities for much longer periods of time. Although they are not available on all stocks, LEAPS are available on most widely held issues.
Options can also be distinguished by when their expiration date falls. Traditionally, listed options have expired on the third Friday of the month. However due to increased demand, sets of options now expire weekly on each Friday, at the end of the month or even on a daily basis.
Options traded on exchanges are called listed options. In the U.S. there are a number of exchanges, both physical and electronic, where options are traded. Options can also be traded directly between counterparties with the use of an exchange; these are known as over-the-counter (OTC) options. Many times, financial institutions will use OTC options to tailor specific outcome events that are not available among listed options. In order to provide liquidity to options markets, there exist market makers who are required to “make” a two-sided market in an option if asked to quote. Market makers, using theoretical pricing models, can take advantage of arbitrage and theoretical mispricings between the options’ perceived value and its market price.
The simple calls and puts we've discussed are sometimes referred to as plain vanilla options. Even though the subject of options can be difficult to understand at first, these plain vanilla options are as easy as it gets. Because of the versatility of options, there are many other types and variations of options. Non-standard options are called exotic options, which are either variations on the payoff profiles of the plain vanilla options or are wholly different products with "option-ality" embedded in them. For example, so-called binary options have a simple payoff structure that is determined if the payoff event happens and doesn’t care about the degree. Other types of exotic options include break-out, break-in, barrier options, lookback options, Asian options and Bermudan options.
Options Basics: How To Read An Options Table
TradingThe ability to exercise only on the expiration date is what sets these options apart.
TradingLearn more about stock options, including some basic terminology and the source of profits.
TradingIndex options are less volatile and more liquid than regular options. Understand how to trade index options with this simple introduction.
TradingOptions are valued in a variety of different ways. Learn about how options are priced with this tutorial.
TradingFutures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying call or put options based on the direction ...