December 1, 2014
December 1, 2014
Table of Contents
Options Market 2
Market Makers 4
Equity Market 6
Works Cited 10
The options market is directly linked to the U.S. economy in many ways. It plays a huge role in various markets and institutions and is reflective of its underlying assets. In this case we will discuss the various issues regarding the options market and how it affects U.S. markets and institutions. ...view middle of the document...
In the options market, option contracts are traded. Those contracts specify the underlying security, the expiration date, and the strike price (meaning, the price at which the person can call or put the securities).
When the strike price in a call option contract of a given security is “in the money” meaning below the current price of the stock, the price to purchase the option is higher. And if the strike price of a call option is “out the money” meaning above the current price of a share of stock, the price to purchase the call option is lower (Milton 2014). Buyers will benefit more when buying “in the money” if the price of the stock increases sometime in the future before the expiration date. In this case, the buyer will have the right to buy shares of stock at a much cheaper price than what it is currently selling on the market and sell it immediately for instant profit. If the price of the security were to decrease lower than the strike price, the buyer of the call option will decide not to exercise the contract and limit its loss to what he or she paid for the call option contract.
The contrary is true when purchasing a put option contracts. When the strike price of the underlying security is “in the money” meaning above the current price of the stock, the price per share to purchase the option is higher. If the strike price of a put option is “out the money” meaning below the current price of the stock, the price to purchase the option is much lower. Buyers of a put option will benefit a great deal buying a “in the money” put option if the price of the stock decreases sometime in the future before the expiration date (Milton 2014). In this case, the buyer will have the right to buy shares of stock at the current market price and then sell it at a much higher price using the put option and receiving instant profit. If the price of the stock were to increase higher than the strike price, the buyer of the option will decide not to exercise the option and limit its loss to what he or she paid for the put option contract.
Another factor that affects the price per share of an option contract is the maturity of the contract. The farthest away the expiration date is the more costly the options are. This is due to probability of volatility in the market. One does not expect the market to change a whole lot in a couple of days (if the expiration date was a week from now), but in the case that the expiration date was three months from now then one would expect a bigger chance of price drops or price spikes. Therefore, to protect themselves from that volatility, sellers or writers increase the price per share on an option contract with long maturity.
An important distinction between buyers and sellers is that buyers of call or put options are not obligated to buy or sell. They only have the choice to exercise their rights if they choose to. On the other hand, sellers (also called writers) of call or put options are obligated to respond to the...