Options And Futures, Basic definitions
futures - a type of contract that gives the right to the sale of certain assets in an amount and at a certain date in the future at a price agreed today.
When buying / selling futures involves three parties: the seller, the buyer and their mediator - the exchange (the clearing centre). The seller undertakes the obligation to buyer that sell assets in the time of the contract price, and the buyer undertakes to make a purchase.
Each futures contract has its own specification. It stipulates the following parameters:
The underlying asset. The futures market is very diverse. The subject of the contract can be as real goods (energy resources, metals, food)and as a financial instrument (shares, bonds, currencies, stock indices).
The standard number. Futures contracts rigidly standardized. For example, one futures contract on Nickel means the delivery of 25 tons of Nickel (one contract), and one contract on the European currency, the purchase or sale of 100 000 (one contract). Thanks to the standardization of sellers and buyers know exactly the amount of the supplied goods. If a buyer wants to buy 50 tons of Nickel, he must buy two futures. However, the 30 tons of Nickel, he can not buy, as the standard contract size - 25 tons of the underlying asset. Transactions in futures contracts are made only on a whole number of contracts.
Date of execution. Expiry of futures contracts is made on the day following the last trading day of the contract.
Terms of delivery (settlement). On this criterion futures contracts can be divided into two types:
Delivery futures contract provides for the actual delivery of the seller and the payment of the purchaser of the underlying asset on the day of execution.
Settlement futures suggests that among the participants shall be made only cash payments (payments of variation margin) on the basis of the difference between the contract price and the actual price of the asset at the date of execution. The physical delivery of the underlying asset is not happening.
In order to ensure performance of obligations on the futures contracts used security Deposit (Deposit margin).
The initial margin is the amount of money required from the participant of exchange trades for the provision of all open positions and for registration of applications. Warranty insurance (TH) usually varies from 10 to 25 percent of the value of the underlying asset. The size of it is closely connected with the volatility (the dynamics of the changes) of the prices in the market.
Option (option) - this is a type of contract which gives the right, but not the obligation, to buy and sell at a fixed price on or before a certain date.
It is necessary to emphasize that the option gives the right, but not the obligation, to make a purchase or sale.
The right to buy any assets is called a call option.
The right to sell is a put option on.
The prize is a fee for the right to buy or sell the option (the option price).
The seller of the option to consent to the performance of the contract, which is different for put options and call, after payment of the prize.
The process, when the holders of the options wish to make use of their right to buy or sell, called the performance of the contract. For a call option, this means that the seller must place the product and to obtain for him the amount fixed in the option contract.
The sellers of the call options take the big risk: they must deliver the goods at a fixed price instead of the prize, despite the rise or fall of prices on the market. If prices rise, retailers have to buy the goods at a higher price, but in order to deliver it at a low price at a loss. The price at which an option contract gives the right to buy or sell, called the strike price of the contract price or strike.
Sellers put options are also faced with a significant risk. They are required to pay the cost of execution of the contract for assets supplied by them. Contracts for the put option is expedient to perform only then, when there is an opportunity to sell assets at a price higher than the market offers.
The risk of sellers of options can be compared with the risk of insurance companies, which for a small prize insure the house from fire, but if the house burns down, the company will be required to pay a large sum of money. The reason the insurance companies and sellers of options go to such a risk, that the house lights are rare and the prices in the market has changed not often.
For investors, buying or holding the option, the risk is limited to the sum of the prize. If a change of the prices in the market is not favorable to the investor, it may not perform an option contract and lose the prize. It should be remembered that the option gives the right, but not the obligation, to perform operations.
The more common types of options are options on futures. Options on futures - a options, the output of which is a long or short futures position.
Thus, as a result of a long a call option holder receives a long position on a futures contract.
As a result of the short put option holder receives a short position in futures.
The effect of leverage.
Margin effect - the most attractive and risk the quality of futures and options.
Consider the example of two options.
Option 1. Buying a call option and the further growth of the value of the underlying asset.
The investor buys a January a call option of the company XYZ at $ 70 for the award 12. The cost of share - 76.
By the end of the term of the contract price of the shares of the company amounted to 100, a call option - 30. Income from 12 invested units amounted to 18.
In percentage terms:
Profit / Initial investment= 18 / 12 * 100% = 150%
If the company's shares were bought at a price of 76 and subsequently were sold at the price of 100, the data would be as follows:
Profit / Initial investment = 24 / 76 * 100% = 31.6%
This shows that the income from operations with options brings more profit compared to the purchase of the underlying asset.
Option 2. Buying a call option and a decrease in the value of the underlying asset.
The investor buys a January a call option of the company XYZ at $ 70 for the award 12. The cost of share - 76.
In the case of the fall of the price per share to 70 by the end of the life of the option, the loss amounted to 12 units or 100%.
Buying a call option -12
The call by the end of the validity period - 0
Loss of = 12 or 100%
If the shares are to be bought at the price of 76 and later sold for 70 with a loss of 6, the percentage would look as follows:
6 / 76 * 100 = 7, 9% - the loss.
The effect of leverage requires special attention, because its misuse can lead to large losses.
