Option — what is it?

  When beginning to study the binary options market, many people decide to find out what an option is in general and become confused, since the concepts of “binary option” and “option” are two different things. An option is a global instrument in the financial market, while binary options belong only to a small subtype of it.

 

What is called an option? 

  An option is a contract under which a potential seller or buyer receives the right, but not the obligation, to sell or buy an asset at an agreed price. The option seller, in turn, assumes responsibility for buying or selling this same asset at the price specified in the contract, regardless of how it relates to the market value.
  Options on goods and services have been used for several centuries. At the very beginning of their history, they were a type of security issued by newly established enterprises. New companies issued options that gave their holders the right to purchase their products at prices much lower than market prices. As a result, the option seller received money to develop the business, and the buyer received more favorable conditions for purchasing goods.

  With the development of the stock exchange, a new chapter in the history of options began. At the beginning of the 19th century, such agreements entered the stock market. There, they began to serve as a guarantee. They were purchased to protect investments in shares.
  Here it is worth explaining in simple terms what options are. For example, you buy shares of a company at 100 rubles each. To make a profit, the shares must rise in price, but the problem is that they can also fall sharply, causing you to lose much of your money. To protect yourself, you can buy a contract under which its seller undertakes to buy these shares from you at 100 rubles each, regardless of their market value. In return, he asks only for a small premium, which is paid regardless of the outcome. You agree with the option seller on the period during which you can sell your shares. If the share price drops significantly, you can recover your money. If the shares rise, you are not obliged to sell them for 100 rubles and can take advantage of a better offer. Just remember that options also cost money, and for the combined purchase of shares and the contract to pay off, their price must rise substantially.
  Recently, another direction in options has been developing — FX. A Forex option is the right to buy or sell currency at a fixed rate. In the Forex market, options also play the role of a kind of guarantor that can protect their holder from major financial losses.

 

Types of options

  First of all, options can be divided into exchange-traded and over-the-counter (commodity and currency).
  Exchange-traded options have recently become more well-known and popular. Commodity contracts, despite appearing earlier, are now used extremely rarely, as more convenient securities exist. Currency options are actively used in the Forex market.
  Options can also be divided into call and put.

 

Call option

 

  A call option is a security that gives its holder the right to buy an asset at a fixed price. The seller is obliged to sell this asset at the agreed price within the specified period. The difference between the fixed and market price is compensated by the seller.

  Buying a call contract is profitable if a price increase is expected in the near future. For the seller, such a deal is profitable only if the price of shares, currency, oil, or gas remains unchanged. By taking on risk, he receives the option premium.
  Call options are an excellent way to earn quickly in case of sharp price fluctuations. For example, you learn that the shares of a large company will soon rise to 200 rubles each, while their current market price is only 150 rubles. You buy a contract to purchase shares at 150 rubles for one month. The option costs 10 rubles, and you buy 100 of them. Later, you can buy the same number of shares under these securities. If the forecast comes true, you buy 100 shares for 150 rubles, spending 15,000 rubles and 1,000 rubles on options, and sell them at the market price for 20,000 rubles. The profit is easy to calculate. Of course, you could earn more by buying shares directly instead of options, but the risk would be much higher.

 

Put option

  This type of option is actively used in stock and currency markets. It is purchased to hedge investments in shares or currency in case of a sharp price decline.
  It gives its holder the right to sell an asset at a previously agreed price (strike price) within the specified period.
  In most cases, such options are not used to generate direct profit. More often, they are bought by shareholders who want to protect themselves from major losses in case of a sharp drop in asset value. In this case, they lose part of their profit due to the option cost. The difference between the strike and market price is borne by the seller.

 

Exotic options

  The very idea of options has produced many branches, many of which have developed significant differences from the original concept. Such options are called exotic or non-standard. In most cases, an exotic option is not an issued security, but an entire financial system that allows significant profit without participating in larger exchange trading. These include:

  1) Asian option.

  The strike price of such an option is not agreed upon jointly by both parties, but is determined by the average price of the underlying asset over a certain period. This approach protects sellers from excessive financial losses in case of price fluctuations.

  2) Barrier option.

  The payout on this security depends on whether the price of the underlying asset reaches a certain level within the agreed period. As a rule, the strike price allows quick profit from price movements, but also increases risk.

  3) Binary options

  Binary options differ significantly from the traditional understanding of the word “option.” Essentially, they are bets on whether the price of an underlying asset will rise or fall. In this area, the concepts of “call” and “put” also exist, but they have a completely different meaning.

 

  We have tried to explain what an option is in simple terms. Hopefully, it is now clear that binary options have only a small resemblance to the original meaning of this word. An intermediate link between exchange-traded (over-the-counter) and binary options are barrier contracts, which involve taking on certain financial risks in order to obtain future profit.