A listed option, also referred to as an exchange-traded option, is a standardized financial contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price before a certain expiry date. These options are traded on regulated exchanges, providing transparency and reducing counterparty risk.
Types of Listed Options
Call Options
A call option gives the holder the right to purchase the underlying asset at a predetermined strike price before the option expires. Investors typically buy call options when anticipating an increase in the underlying asset’s price.
Put Options
A put option grants the holder the right to sell the underlying asset at a specified strike price before the expiration date. Investors generally buy put options when expecting a decline in the underlying asset’s price.
Special Considerations
Standardization and Regulation
Listed options are standardized in terms of strike prices, expiration dates, and contract sizes. This standardization facilitates trading, pricing, and liquidity. Regulatory bodies, such as the Securities and Exchange Commission (SEC) in the United States, establish rules for options trading, ensuring market integrity and protecting investors.
Exchange Platforms
Options are traded on various exchanges, including the Chicago Board Options Exchange (CBOE), NASDAQ, and the New York Stock Exchange (NYSE). These platforms provide the infrastructure for order matching, price discovery, and execution.
Examples
Purchase of a Call Option
An investor buys a call option on a stock with a strike price of $50, expiring in three months, for a premium of $5. If the stock price rises to $60 before expiration, the investor can exercise the option to buy at $50, realizing a profit.
Hedging with Put Options
An investor holding a portfolio of stocks anticipates a market downturn. They buy put options as insurance. If the market falls, the gains from the put options can offset some of the losses in the portfolio.
Historical Context
The concept of options dates back to ancient times, but the modern listed options market began in 1973 with the establishment of the Chicago Board Options Exchange (CBOE). The development of the Black-Scholes pricing model at the same time revolutionized the valuation of options, leading to exponential growth in the market.
Applicability
Listed options serve various purposes, including speculative trading, hedging risk, and enhancing portfolio returns through strategies such as covered calls and protective puts. They are widely used by individual investors, hedge funds, and institutional investors.
Comparisons
Listed Options vs. Over-the-Counter (OTC) Options
- Transparency: Listed options offer greater transparency as they are traded on public exchanges, while OTC options are privately negotiated.
- Standardization: Listed options are standardized, whereas OTC options can be customized.
- Counterparty Risk: Listed options reduce counterparty risk through the clearinghouse, while OTC options involve direct counterparty exposure.
Related Terms
- Strike Price: The predetermined price at which the underlying asset can be bought or sold.
- Premium: The price paid for the option contract.
- Expiration Date: The date on which the option expires.
- Underlying Asset: The financial instrument (e.g., stock, index) on which the option is based.
FAQs
What are the benefits of trading listed options?
Can listed options expire worthless?
How are listed options taxed?
References
- Black, F., & Scholes, M. (1973). “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy.
- Hull, J. (2017). “Options, Futures, and Other Derivatives.” Pearson.
Summary
Listed options are integral financial instruments in modern markets, offering numerous strategic benefits for hedging, speculation, and income generation. Their standardized nature and exchange-based trading enhance transparency and reduce risks, making them accessible and valuable tools for a broad spectrum of investors.
