What is the essence of options?

Option is a kind of contract, which gives the holder the right to buy or sell an asset at an agreed price on or before a specific date and belongs to derivative financial instruments.

The so-called option, taken apart, is actually "item"+"right". Two words tell its core essence at a glance. The essence of option is to separate the rights and obligations in the financial field, so that the transferee (option buyer) has the right to decide whether to trade at the agreed price within the specified time, while the obligor (option seller) bears the obligations that must be fulfilled.

Image source: Baidu, search for financial options.

Because the rights of options include both the right to buy assets at the agreed price within the agreed period and the right to sell assets, they are divided into call options and put options.

According to the types of options, ordinary options are divided into American options and European options. If an option can only be exercised on the expiration date, it is called a European option. If an option can be exercised at any time on or before the expiration date, it is called an American option. The American stock options we trade are typical American options.

2. What does it mean to buy options?

Just saying that the definition may be too abstract, let's go back to the example of buying a house above and understand what it means to buy an American call option ~

It is said that you signed a contract with the owner, paid him a deposit of 30 thousand yuan, and agreed to buy this house at a price of 3 million yuan within three months. The owner took the money and undertook the obligation of selling the house to you for 3 million yuan within 3 months. You bought the corresponding rights at the price of 30,000 yuan. This margin is equivalent to the premium paid for the option.

When paying the down payment, two more things may happen.

1. As you expected, the house price rose faster and faster, reaching 4 million in three months. So you took the contract to the owner and asked to buy the house at a price of 3 million according to the contract. Since the owner has signed the contract and received the deposit, he can only sell the house in tears.

So you earned 970,000 yuan in one breath (4 million current price -3 million actual transaction price-30,000 deposit).

2. The house price plummeted suddenly and fell by half in three months. The original 3 million house can only sell for 6.5438+0.5 million now, and the price you negotiated with the owner at that time was 3 million. At this time, you are relieved, glad that you bought an "option" instead of a house, and then tactfully tore up the contract.

30,000 yuan is gone, but it also avoids the risk of losing another 6.5438+0.5 million yuan. (About the current price of 3 million-1.50 thousand)

In the above example, the contract you agreed with the homeowner is essentially a call option, and the deposit you paid is equivalent to the premium of the option, which is also the money we spent on purchasing the option. The agreed transaction price (3 million) is the exercise price.

But if the house price rises and you change your mind and don't want to buy it, you can still sell this option to others at a high price within the time limit, and vice versa, so the price of this right (royalty) will fluctuate with the house price and the relationship between supply and demand.

On the other hand, unlike you, the homeowner in this example is equivalent to the seller of options and has already assumed the obligation by collecting "royalties". As long as you choose to perform (exercise), he must cooperate.

So for people who buy options, the biggest loss is all the "royalties", and the biggest gain can be unlimited in theory.