Introduction to Option Markets

What an option contract is.

The difference between a futures contract and an option contract.

The risks/return characteristics of a contract.

The basic components of the option price.

The factors that influence the option price.

The fundamentals of option pricing models.

The principles of the binominal option pricing model and how it is derived.

The role of option in financial markets

Two types of exotic known as alternative options and outperformance option.

Option contract
An option is a contract in which the writer of the option grants the buyer of
the option the right, but not the obligation, to purchase from or sell to the
writer something at a specified price within a specified period of time (or
at a specified date). The writer, also referred to as the seller, grants this
right to the buyer in exchange for a certain sum of money, which is called
the option price or option premium.

Differences between options and futures contracts

Notice that, unlike in futures contract, one party to an option

contract is not obligated to transact-specifically, the option buyer
has the right but not the obligation to transact. The option writer
does have the obligation to perform. In the case of a futures
contract, both buyer and seller are obligated to perform. Of
course, a futures buyer does not pay the seller to accept the
obligation, while an option buyer pays the seller an option price.

Risk and return characteristics of option

Here we illustrate the risk and return characteristics of the four

basic option position: buying a call option, selling a call option,
buying a put option, selling a put option. The illustrations assume
that each option position is held to the expiration date and not
exercised early. Also, to simplify the illustration, we ignore
transactions costs.

Basic components of the option price

Intrinsic Value

The price at which the option owner is allowed to either buy or sell the
underlying asset is called the strike price

Intrinsic value is only one component of option pricing, the other is time
value, which is equal to the option price less the intrinsic price.

Time Value

The factors that influence the option price.

There are six primary factors that influence option prices

As indicated, the underlying price and strike price determine the intrinsic
value; the time until expiration and volatility determine the probability of a
profitable move; the interest rates determine the cost of money; and
dividends can cause an adjustment to share price.

The role of option in financial markets

The financial derivatives are financial instruments, that are recently created, and
whose main application is to be used as a tool for managing financial derivatives. The
most significant financial derivatives are options that are mostly used for their
flexible and non-standard character. Options, and the other financial derivatives, as
well, are instruments that are derived from some other financial instruments that
makes them more complicated from one hand, and more risky, from the other hand.
Their role is very important for the developing the financial system, and generating
economic growth. The subject of research in this paper is the options as an
unstandardized financial derivatives, and their basic characteristics and usage in
developed, and developing countries. The prime goal is to research the importance of
these derivatives in developing countries, with basic focus in the Republic of
Macedonia. The results from these paper should suggest if the options are curtail for
the developing the Macedonian financial markets.

outperformance options

OUTPERFORMANCE OPTION

An exotic call option that's value is determined by the differing

performance of two underling assets or securities. The holder
gains on the amount one asset outperforms another, both of
which are pre-determined. These options are typically Europeanstyle, settled in cash, and traded in the over-the-counter market.