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In finance, the style or family of an option is the class into which the option falls, usually defined by the dates on which the option may be exercised. The vast majority of options are either European or American (style) options. These options—as well as others where the payoff is calculated similarly—are referred to as " vanilla options". Options where the payoff is calculated differently are categorized as "
exotic option In finance, an exotic option is an option which has features making it more complex than commonly traded vanilla options. Like the more general exotic derivatives they may have several triggers relating to determination of payoff. An exotic op ...
s". Exotic options can pose challenging problems in valuation and hedging.


American and European options

The key difference between American and European options relates to when the options can be exercised: * A European option may be exercised only at the expiration date of the option, i.e. at a single pre-defined point in time. * An American option on the other hand may be exercised at any time before the expiration date. For both, the payoff—when it occurs—is given by * \max\, for a
call option In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call option to exchange a security at a set price. The buyer of the call option has the right, but not the obligation, to buy ...
* \max\, for a
put option In finance, a put or put option is a derivative instrument in financial markets that gives the holder (i.e. the purchaser of the put option) the right to sell an asset (the ''underlying''), at a specified price (the ''strike''), by (or at) a ...
where K is the
strike price In finance, the strike price (or exercise price) of an option is a fixed price at which the owner of the option can buy (in the case of a call), or sell (in the case of a put), the underlying security or commodity. The strike price may be set ...
and S is the spot price of the underlying asset.
Option contract An option contract, or simply option, is defined as "a promise which meets the requirements for the formation of a contract and limits the promisor's power to revoke an offer". Option contracts are common in professional sports. An option contrac ...
s traded on
futures exchange A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts defined by the exchange. Futures contracts are derivatives contracts to buy or sell specific quantities of a commodity o ...
s are mainly American-style, whereas those traded
over-the-counter Over-the-counter (OTC) drugs are medicines sold directly to a consumer without a requirement for a prescription from a healthcare professional, as opposed to prescription drugs, which may be supplied only to consumers possessing a valid prescr ...
are mainly European. Nearly all stock and equity options are American options, while indexes are generally represented by European options. Commodity options can be either style.


Expiration date

Traditional monthly American options expire the third Saturday of every month (or the third Friday if the first of the month begins on a Saturday). They are closed for trading the Friday prior. European options expire the Friday prior to the third Saturday of every month. Therefore, they are closed for trading the Thursday prior to the third Saturday of every month.


Difference in value

Assuming an arbitrage-free market, a
partial differential equation In mathematics, a partial differential equation (PDE) is an equation which imposes relations between the various partial derivatives of a multivariable function. The function is often thought of as an "unknown" to be solved for, similarly to h ...
known as the Black-Scholes equation can be derived to describe the prices of derivative securities as a function of few parameters. Under simplifying assumptions of the widely adopted Black model, the Black-Scholes equation for European options has a closed-form solution known as the Black-Scholes formula. In general, no corresponding formula exist for American options, but a choice of methods to approximate the price are available (for example Roll-Geske-Whaley, Barone-Adesi and Whaley, Bjerksund and Stensland, binomial options model by Cox-Ross-Rubinstein, Black's approximation and others; there is no consensus on which is preferable). Obtaining a general formula for American options without assuming constant volatility is one of finance's unsolved problems. An investor holding an American-style option and seeking optimal value will only exercise it before maturity under certain circumstances. Owners who wish to realise the full value of their option will mostly prefer to sell it as late as possible, rather than exercise it immediately, which sacrifices the time value. Where an American and a European option are otherwise identical (having the same
strike price In finance, the strike price (or exercise price) of an option is a fixed price at which the owner of the option can buy (in the case of a call), or sell (in the case of a put), the underlying security or commodity. The strike price may be set ...
, etc.), the American option will be worth at least as much as the European (which it entails). If it is worth more, then the difference is a guide to the likelihood of early exercise. In practice, one can calculate the Black–Scholes price of a European option that is equivalent to the American option (except for the exercise dates of course). The difference between the two prices can then be used to calibrate the more complex American option model. To account for the American's higher value there must be some situations in which it is optimal to exercise the American option before the expiration date. This can arise in several ways, such as: * An
in the money In finance, moneyness is the relative position of the current price (or future price) of an underlying asset (e.g., a stock) with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a thr ...
(ITM)
call option In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call option to exchange a security at a set price. The buyer of the call option has the right, but not the obligation, to buy ...
on a
stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a compan ...
is often exercised just before the stock pays a
dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...
that would lower its value by more than the option's remaining time value. * A
put option In finance, a put or put option is a derivative instrument in financial markets that gives the holder (i.e. the purchaser of the put option) the right to sell an asset (the ''underlying''), at a specified price (the ''strike''), by (or at) a ...
will usually be exercised early if the underlying asset files for bankruptcy. * A deep ITM
currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general ...
option (FX option) where the strike currency has a lower interest rate than the currency to be received will often be exercised early because the time value sacrificed is less valuable than the expected depreciation of the received currency against the strike. * An American bond option on the dirty price of a
bond Bond or bonds may refer to: Common meanings * Bond (finance), a type of debt security * Bail bond, a commercial third-party guarantor of surety bonds in the United States * Chemical bond, the attraction of atoms, ions or molecules to form chemical ...
(such as some
convertible bond In finance, a convertible bond or convertible note or convertible debt (or a convertible debenture if it has a maturity of greater than 10 years) is a type of bond that the holder can convert into a specified number of shares of common stock ...
s) may be exercised immediately if ITM and a coupon is due. * A
put option In finance, a put or put option is a derivative instrument in financial markets that gives the holder (i.e. the purchaser of the put option) the right to sell an asset (the ''underlying''), at a specified price (the ''strike''), by (or at) a ...
on
gold Gold is a chemical element with the symbol Au (from la, aurum) and atomic number 79. This makes it one of the higher atomic number elements that occur naturally. It is a bright, slightly orange-yellow, dense, soft, malleable, and ductile ...
will be exercised early when deep ITM, because gold tends to hold its value whereas the
currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general ...
used as the strike is often expected to lose value through
inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
if the holder waits until final maturity to exercise the option (they will almost certainly exercise a contract deep ITM, minimizing its time value).


Less common exercise rights

There are other, more unusual exercise styles in which the payoff value remains the same as a standard option (as in the classic American and European options above) but where early exercise occurs differently:


Bermudan option

*A Bermudan option is an option where the buyer has the right to exercise at a set (always discretely spaced) number of times. This is intermediate between a European option—which allows exercise at a single time, namely expiry—and an American option, which allows exercise at any time (the name is jocular:
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, a
British overseas territory The British Overseas Territories (BOTs), also known as the United Kingdom Overseas Territories (UKOTs), are fourteen territories with a constitutional and historical link with the United Kingdom. They are the last remnants of the former Br ...
, is somewhat American and somewhat European—in terms of both option style and physical location—but is nearer to American in terms of both). For example, a typical Bermudian swaption might confer the opportunity to enter into an
interest rate swap In finance, an interest rate swap (IRS) is an interest rate derivative (IRD). It involves exchange of interest rates between two parties. In particular it is a "linear" IRD and one of the most liquid, benchmark products. It has associations with ...
. The option holder might decide to enter into the swap at the first exercise date (and so enter into, say, a ten-year swap) or defer and have the opportunity to enter in six months time (and so enter a nine-year and six-month swap); see Swaption: Valuation. Most exotic interest rate options are of Bermudan style.


Canary option

* A Canary option is an option whose exercise style lies somewhere between European options and Bermudian options. (The name refers to the relative geography of the
Canary Islands The Canary Islands (; es, :es:Canarias, Canarias, ), also known informally as the Canaries, are a Spanish Autonomous communities of Spain, autonomous community and archipelago in the Atlantic Ocean, in Macaronesia. At their closest point to ...
.) Typically, the holder can exercise the option at quarterly dates, but not before a set time period (typically one year) has elapsed. The ability to exercise the option ends prior to the maturity date of the product. The term was coined by Keith Kline, who at the time was an agency fixed income trader at the Bank of New York.


Capped-style option

* A capped-style option is not an
interest rate cap An interest rate cap is a type of interest rate derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price. An example of a cap would be an agreement to receive a payment f ...
but a conventional option with a pre-defined profit cap written into the contract. A capped-style option is ''automatically exercised'' when the underlying security closes at a price making the option's
mark to market Mark-to-market (MTM or M2M) or fair value accounting is accounting for the " fair value" of an asset or liability based on the current market price, or the price for similar assets and liabilities, or based on another objectively assessed "fai ...
match the specified amount.


Compound option

* A compound option is an option on another option, and as such presents the holder with two separate exercise dates and decisions. If the first exercise date arrives and the 'inner' option's market price is below the agreed strike the first option will be exercised (European style), giving the holder a further option at final maturity.


Shout option

* A shout option allows the holder effectively two exercise dates: during the life of the option they can (at any time) "shout" to the seller that they are locking-in the current price, and if this gives them a better deal than the payoff at maturity they'll use the underlying price on the shout date rather than the price at maturity to calculate their final payoff.


Double option

* A double option gives the purchaser a composite call-and-put option (an option to either buy or sell) in a single contract. This has only ever been available in commodities markets and has never been traded on exchange.


Swing option

* A swing option gives the purchaser the right to exercise one and only one call or put on any one of a number of specified exercise dates (this latter aspect is Bermudan). Penalties are imposed on the buyer if the net volume purchased exceeds or falls below specified upper and lower limits. Allows the buyer to "swing" the price of the underlying asset. Primarily used in energy trading.


Evergreen option

* An evergreen option is an option where the buyer has the right to exercise by providing a pre-determined period of notice. This option could be either American or European in nature or alternatively it could be combined with option styles that have non-vanilla exercise rights. For example, an ‘Evergreen-Bermudan’ option provides the buyer of the option with the right to exercise at set specific points in time after providing the other counterparty with a pre-determined period of notice of their intent to exercise the option. Evergreen options provide sellers with a period of time to prepare for settlement once the buyer has exercised their rights under the option. Embedding evergreen optionality within on and off-balance sheet products can enable counterparties (such as banks that must adhere to Basel III) to lengthen their inflow or outflow obligations.


"Exotic" options with standard exercise styles

These options can be exercised either European style or American style; they differ from the plain vanilla option only in the calculation of their payoff value:


Composite option

* A cross option (or composite option) is an option on some underlying asset in one
currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general ...
with a strike denominated in another currency. For example, a standard
call option In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call option to exchange a security at a set price. The buyer of the call option has the right, but not the obligation, to buy ...
on IBM, which is denominated in
dollars Dollar is the name of more than 20 currencies. They include the Australian dollar, Brunei dollar, Canadian dollar, Hong Kong dollar, Jamaican dollar, Liberian dollar, Namibian dollar, New Taiwan dollar, New Zealand dollar, Singapore dollar, U ...
, pays \max(S-K,0) \cdot \text (where S is the stock price at maturity and K is the strike price). A composite stock option might instead pay \max((S-K),0) FX_T \cdot \text, where FX_T is the prevailing exchange rate, that is, FX_T \cdot \text = 1 \cdot \text on the exercise date. The pricing of such options naturally needs to take into account exchange rate volatility and the
correlation In statistics, correlation or dependence is any statistical relationship, whether causal or not, between two random variables or bivariate data. Although in the broadest sense, "correlation" may indicate any type of association, in statistic ...
between the
exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of t ...
of the two currencies involved and the underlying stock price.


Quanto option

* A quanto option is a cross option in which the exchange rate is fixed at the outset of the trade, typically at 1. These options are often used by traders to gain exposure to foreign markets without exposure to exchange rate. Continuing the example from the composite option, the payoff of an IBM quanto call option would then be \max((S-K),0) FX_0 \cdot \text, where FX_0 is the exchange rate fixed at the outset of the trade. This would be useful for traders in Japan who wish to be exposed to IBM stock price without exposure to JPY/USD exchange rate.


Exchange option

* An exchange option is the right to exchange one asset for another (such as a sugar future for a corporate
bond Bond or bonds may refer to: Common meanings * Bond (finance), a type of debt security * Bail bond, a commercial third-party guarantor of surety bonds in the United States * Chemical bond, the attraction of atoms, ions or molecules to form chemical ...
).


Basket option

* A basket option is an option on the weighted average of several underlyings.


Rainbow option

* A rainbow option is a basket option where the weightings depend on the final performances of the components. A common special case is an option on the worst-performing of several stocks.


Low Exercise Price Option

* A Low Exercise Price Option (LEPO) is a European style call option with a low exercise price of $0.01.


Boston option

* A
Boston option A Boston option, also known as a deferred premium option, is a type of American option. This type of option is considered a long-term option due to how premium payments are usually due a year after a contract is started. Many of the traded options ...
is an American option but with premium deferred until the option expiration date.


Non-vanilla path-dependent "exotic" options

The following "
exotic option In finance, an exotic option is an option which has features making it more complex than commonly traded vanilla options. Like the more general exotic derivatives they may have several triggers relating to determination of payoff. An exotic op ...
s" are still options, but have payoffs calculated quite differently from those above. Although these instruments are far more unusual they can also vary in exercise style (at least theoretically) between European and American:


Lookback option

* A lookback option is a path dependent option where the option owner has the right to buy (sell) the underlying instrument at its lowest (highest) price over some preceding period.


Asian option

* An
Asian option An Asian option (or ''average value'' option) is a special type of option contract. For Asian options the payoff is determined by the average underlying price over some pre-set period of time. This is different from the case of the usual European o ...
(or average option) is an option where the payoff is not determined by the underlying price at maturity but by the average underlying price over some pre-set period of time. For example, an Asian call option might pay MAX(DAILY_AVERAGE_OVER_LAST_THREE_MONTHS(S) − K, 0). Asian options were originated in commodity markets to prevent option traders from attempting to manipulate the price of the underlying security on the exercise date. They were named 'Asian' because their creators were in Tokyo when they created the first pricing model * A Russian option is a lookback option that runs for perpetuity. That is, there is no end to the period into which the owner can look back.


Game option

* A game option or Israeli option is an option where the writer has the opportunity to cancel the option she has offered, but must pay the payoff at that point plus a penalty fee.


Cumulative Parisian option

* The payoff of a cumulative Parisian option is dependent on the total amount of time the underlying asset value has spent above or below a strike price.


Standard Parisian option

*The payoff of a standard Parisian option is dependent on the maximum amount of time the underlying asset value has spent ''consecutively'' above or below a strike price.


Barrier option

* A barrier option involves a mechanism where if a 'limit price' is crossed by the underlying, the option either can be exercised or can no longer be exercised.


Double barrier option

* A double barrier option involves a mechanism where if either of two 'limit prices' is crossed by the underlying, the option either can be exercised or can no longer be exercised.


Cumulative Parisian barrier option

* A cumulative Parisian barrier option involves a mechanism, in which if the total amount of time the underlying asset value has spent above or below a 'limit price' exceeds a certain threshold, then the option can be exercised or can no longer be exercised.


Standard Parisian barrier option

* A standard Parisian barrier option involves a mechanism, in which if the maximum amount of time the underlying asset value has spent consecutively above or below a 'limit price' exceeds a certain threshold, the option can be exercised or can no longer be exercised.


Reoption

* A reoption occurs when a contract has expired without having been exercised. The owner of the underlying security may then reoption the security.


Binary option

* A binary option (also known as a digital option) pays a fixed amount, or nothing at all, depending on the price of the underlying instrument at maturity.


Chooser option

* A chooser option gives the purchaser a fixed period of time to decide whether the derivative will be a vanilla call or put.


Forward start option

* A
forward start option In finance, a forward start option is an option that starts at a specified future date with an expiration date set further in the future. A forward start option starts at a specified date in the future; however, the premium is paid in advance, a ...
is an option whose strike price is determined in the future.


Cliquet option

* A
cliquet option A cliquet option or ratchet option is an exotic option consisting of a series of consecutive forward start options. The first is active immediately. The second becomes active when the first expires, etc. Each option is struck at-the-money when it ...
is a sequence of forward start options.


See also

* CBOE *
Derivative (finance) In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be use ...
*
Derivatives market The derivatives market is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets. The market can be divided into two, that for exchange-traded derivatives a ...
s *
Financial economics Financial economics, also known as finance, is the branch of economics characterized by a "concentration on monetary activities", in which "money of one type or another is likely to appear on ''both sides'' of a trade". William F. Sharpe"Financia ...
*
Financial instrument Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity or a contractual right to receive or deliver in the form ...
*
Finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of f ...
*
Futures contract In finance, a futures contract (sometimes called a futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The asset ...
s *
Monte Carlo methods in finance Monte Carlo methods are used in corporate finance and mathematical finance to value and analyze (complex) instruments, portfolios and investments by simulating the various sources of uncertainty affecting their value, and then determining the dis ...
* Option screeners


Options

* Binary option * Bond option * Credit default option * Exotic interest rate option * Foreign exchange option * Interest rate cap and floor * Options on futures * Rainbow option * Real option *
Stock option In finance, an option is a contract which conveys to its owner, the ''holder'', the right, but not the obligation, to buy or sell a specific quantity of an underlying asset or instrument at a specified strike price on or before a specified d ...
* Swaption * Warrant


Related

* Covered call *
Moneyness In finance, moneyness is the relative position of the current price (or future price) of an underlying asset (e.g., a stock) with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a thr ...
* Naked put *
Option (finance) In finance, an option is a contract which conveys to its owner, the ''holder'', the right, but not the obligation, to buy or sell a specific quantity of an underlying asset or financial instrument, instrument at a specified strike price on or be ...
*
Option time value In finance, the time value (TV) (''extrinsic'' or ''instrumental'' value) of an option is the premium a rational investor would pay over its ''current'' exercise value ( intrinsic value), based on the probability it will increase in value before ex ...
*
Put option In finance, a put or put option is a derivative instrument in financial markets that gives the holder (i.e. the purchaser of the put option) the right to sell an asset (the ''underlying''), at a specified price (the ''strike''), by (or at) a ...
*
Put–call parity In financial mathematics, put–call parity defines a relationship between the price of a European call option and European put option, both with the identical strike price and expiry, namely that a portfolio of a long call option and a short pu ...
* Smooth pasting


References


External links


option types data base
global-derivatives.com
Varieties of programming codes on option valuation
{{DEFAULTSORT:Option Style Options (finance)