Options and futures in financial markets – Banks & Financial Markets

Options and futures are derivative financial instruments commonly traded in banks and financial markets. They provide investors with opportunities for speculation, hedging, and risk management. Here’s an overview of options and futures in financial markets:

Options:

1. Option Contracts: Options grant the holder the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) within a predetermined period (expiration date).
2. Call Options: Call options give the holder the right to buy the underlying asset at the strike price. Call options are often used by investors who anticipate an increase in the price of the underlying asset.
3. Put Options: Put options give the holder the right to sell the underlying asset at the strike price. Put options are commonly used by investors who expect a decline in the price of the underlying asset.
4. Option Premium: The price paid to acquire an option contract is called the option premium. The premium is influenced by factors such as the underlying asset’s price, volatility, time to expiration, and interest rates.
5. Option Exercising: Option holders can choose to exercise their options if it is profitable for them. In the case of American-style options, holders can exercise the option at any time before the expiration date. European-style options, on the other hand, can only be exercised at expiration.
6. Option Writing: Investors can also sell (write) options to generate income. Option writers assume the obligation to fulfill the terms of the option contract if the option holder decides to exercise it.

Futures:

1. Futures Contracts: Futures contracts are agreements to buy or sell an underlying asset at a predetermined price (futures price) on a specified future date. Futures contracts are standardized, with specific contract sizes and expiry dates.
2. Long and Short Positions: In futures trading, investors take either long or short positions. Going long means buying a futures contract with the expectation that the price of the underlying asset will rise. Going short involves selling a futures contract in anticipation of a price decline.
3. Margin and Leverage: Futures trading involves the use of margin, which is a deposit made by the trader to cover potential losses. Margin allows traders to control a larger position with a smaller initial investment, amplifying both potential profits and losses.
4. Mark-to-Market: Futures contracts are marked to market daily, meaning that gains or losses are settled on a daily basis. Profits or losses are credited or debited to the trader’s account based on the daily price movements of the futures contract.
5. Delivery and Settlement: While some futures contracts result in physical delivery of the underlying asset, most futures contracts are cash-settled, meaning that the gains or losses are settled in cash without the physical exchange of the asset.
6. Hedging: Futures contracts are widely used for hedging purposes. Businesses and investors can use futures contracts to offset price risks associated with the underlying assets they own or intend to acquire in the future.

Options and futures are complex financial instruments, and trading them involves risks. Investors should understand the mechanics, strategies, and associated risks before engaging in options and futures trading. It’s advisable to seek advice from qualified financial professionals and conduct thorough research to make informed investment decisions.