An option holder is an individual or entity that has purchased a financial derivative known as an option but has not yet exercised, sold, or let the option expire. There are two primary types of options: Call Options and Put Options. Each type of option grants the holder specific rights regarding the underlying asset.
Call Option Holder
A call option holder has purchased the right, but not the obligation, to buy an underlying security (such as a stock) at a predetermined price, known as the strike price, within a specified time frame. The call option holder benefits when the price of the underlying security rises above the strike price, as they can buy the security at a lower price and potentially sell it at a higher market price.
Put Option Holder
A put option holder has purchased the right, but not the obligation, to sell an underlying security at the strike price within a specified time frame. The put option holder profits when the price of the underlying security falls below the strike price, as they can sell the security at a higher strike price while the market price is lower, thereby securing a profit.
Types of Options
American Options
American options can be exercised at any point before the expiration date, providing more flexibility to the option holder.
European Options
European options can only be exercised on the expiration date itself, limiting the timeframe within which the option holder can act.
Special Considerations
- Expiration Date: The date by which the option must be exercised or it becomes void.
- Premium: The price paid by the option holder to acquire the option.
- Strike Price: The set price at which the option holder can buy or sell the underlying security.
Examples
Call Option Example
Jane purchases a call option for XYZ Corporation at a strike price of $50, expiring in one year. The current price of XYZ stocks is $45. If the price of XYZ rises to $60 within the year, Jane can exercise her option to buy the stocks at $50 and sell them at the market price of $60, making a profit.
Put Option Example
John buys a put option for ABC Corporation at a strike price of $40, expiring in six months. The current market price of ABC stocks is $45. If the price of ABC falls to $30 within six months, John can exercise his option to sell the stocks at $40, thus making a profit.
Historical Context
Options have a storied history dating back to ancient times but gained significant popularity in the modern financial markets during the 20th century. The establishment of the Chicago Board Options Exchange (CBOE) in 1973 marked the standardization and increased regulation of options trading.
Applicability
Option holders play a crucial role in financial markets, offering strategies for risk management and speculative opportunities. Options are used in various financial strategies, including hedging, income generation, and directional plays based on market predictions.
Related Terms
- Strike Price: The price at which an option holder can buy (call) or sell (put) the underlying asset.
- Premium: The cost paid by the option holder to purchase the option.
- Expiration Date: The last date on which the option can be exercised.
FAQs
What happens if an option holder does not exercise the option?
Can options be sold before expiration?
What are the risks involved for option holders?
References
- Black, F., & Scholes, M. (1973). The Pricing of Options and Corporate Liabilities. Journal of Political Economy.
- Hull, J. C. (2014). Options, Futures, and Other Derivatives. Pearson Education Limited.
Summary
An option holder is an investor who has purchased an option—call or put—granting them the right but not the obligation to buy or sell an underlying asset at a predetermined price within a set timeframe. Call option holders benefit from rising prices, while put option holders benefit from falling prices. Understanding the mechanics, types, and risks of options is crucial for effective financial strategizing.
