Page 128 - Microsoft Word - 00 P1 IW Prelims.docx

Chapter 8

Introduction

1.1 Definition of an option

An option is the right but not the obligation, to buy or sell a particular
good at a fixed exercise price, at or before a specified date.

 Call option – the right but not the obligation to BUY a particular
good at a fixed exercise price.

 Put option – the right but not the obligation to SELL a particular
good at a fixed exercise price.

1.2 Important terminology

 Exercise price / strike price – the fixed price at which the good may be bought
or sold.

 American option – an option that can be exercised on any day up until its
expiry date.

 European option – an option that can only be exercised on the last day of the
option.

 Traded options – standardised option contracts sold on a futures exchange
(normally American options).

 Over the counter (OTC) options – tailor-made options – usually sold by a
bank (normally European options).

116