What are options and how can they be used to hedge and speculate? What are swaps and how are they used to hedge and speculate?
Options are aptly named financial derivatives that give their holders the option which is to say the right, but not the obligation to purchase call or sell put an underlying asset at a predetermined strike price, on if a so-called European option or before if a so-called American option a predetermined expiration date.
Options are most often written on stocks equities but can be linked to other types of assets as option issuers.
To induce investors to issue an option and thereby obligate themselves to make a disadvantageous trade, option holders must pay a premium to the option issuer based on the option type, strike price, expiration date, interest rates, and option issuers of the underlying asset. The most famous option valuation model is called Black-Scholes. An investor might buy a call option on a stock in the hopes that the stock price will rise above the strike price, allowing her to buy the stock at the option issuers price e.
Or an investor might buy a put option to minimize his losses.
Buying and selling calls and puts can be combined to create a variety of investment strategies with colorful names like bear put spreads and bull collars. Do yourself a favor and study the subject more thoroughly before dabbling in options, especially before selling them. Similarly, if the market price e.
The seller of an option, option issuers contrast, can lose a large sum if an option goes a long way into the money. Such large movements are rare, of course, but it would only take one instance to ruin most individual option issuers. Stop and Think Box All else equal, what should cost more to purchase, an American or a European option?
Swaps are very different from options though option issuers can be combined to form a derivative called a swaption, or an option to enter into a swap. As the name implies, swaps are exchanges of one asset for another on a predetermined, typically repeated basis.
Difference between Convertible Bonds, Warrants, Options, ESOPS
Such an agreement, called an interest rate swap, would buffer the bank against rising interest rates while protecting the finance company from lower ones, as in the following table: Table