Derivatives – Options and Futures Flashcards

What is a 'call option' in derivatives?

Answer: An option giving the holder the right but not the obligation to buy an asset at the strike price before or on the expiry date

A call option gives the buyer the right (but not the obligation) to purchase the underlying asset at the agreed strike price on or before the expiry date. The buyer pays a premium for this right. Call options are used to speculate on rising prices or hedge short positions.

What is a 'put option' in derivatives?

Answer: An option giving the holder the right but not the obligation to sell an asset at the strike price on or before expiry

A put option gives the buyer the right (but not the obligation) to sell the underlying asset at the agreed strike price on or before expiry. Put options are used to speculate on falling prices or to hedge an existing long position against downside risk.

What is the 'premium' of an option?

Answer: The price paid by the option buyer to the option seller (writer) for the right conferred by the option contract

The option premium is the price paid upfront by the option buyer to the seller (writer) in exchange for the rights conferred by the option. For the buyer, the premium is the maximum loss. For the writer, the premium is their maximum profit.

What is a 'futures contract'?

Answer: A legally binding agreement to buy or sell a standardised amount of an asset at a specified price on a specified future date

A futures contract is a standardised, exchange-traded agreement that obligates both parties — buyer and seller — to transact the underlying asset at the agreed price on the specified future delivery date. Unlike options, both parties have an obligation, not just a right.

What is 'delta' in options pricing?

Answer: The sensitivity of an option's price to a £1 change in the price of the underlying asset, ranging from 0 to 1 for calls and -1 to 0 for puts

Delta measures how much an option's price changes for a £1 move in the underlying asset. A call option with a delta of 0.5 will increase by approximately 50p for each £1 rise in the underlying. Delta-hedging involves adjusting positions to maintain a neutral delta.

What is the difference between an 'American' and a 'European' option?

Answer: An American option can be exercised at any time up to and including expiry; a European option can only be exercised on the expiry date itself

The key distinction is exercise flexibility: American options can be exercised at any point before or on expiry, giving the holder more flexibility. European options can only be exercised on the specific expiry date. This makes American options typically more valuable.