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Options Basic Terminology

Options are derivative financial instruments that give the buyer the right, but not the obligation, to buy or sell an asset at a predetermined price at any time before a specified date. Underlying asset in currency options for example is a currency pair for which the option gives the right to be bought or sold. The more liquid is this pair, the more liquid are its options. Each option has a strike price at which it could be exercised before or at the expiration date. Furthermore, the option is buyer pays a premium, which is the price of the option. This price is a result of direct competition and negotiation between market players according to the rules of the exchange or the OTC market. You must learn to distinguish between the two prices. The premium is the price at which the option is traded as a financial instrument, while the strike is the price at which the buyer of the option buy or sell the underlying asset at or before the expiry.

Plain vanilla (or just vanilla), according to the right which they provide, are two types - call and put. Call option entitles its owner to buy an asset at a specified price at or before the expiry of the option. Put option entitles its owner to sell an asset at a specified price at or before the expiry of the option. In addition, each option has a seller (writer) and a buyer. Because of the involvement of two different currencies quoted in different ways for the FX options, sometimes is said not only that a call option on EUR/USD is traded, but could be specified which currency will be bought and which sold- EUR call/USD put.

The expiry of the option is the last date by which it must be exercised or the position could be closed by offset operation. After the occurrence of that date, its rights lose their power and it may no longer be valid. American style options can be exercise at any time before the maturity, while the European only on that date at a specific time (usually one of the major fixings).