Financial Tutorial
 

Options: Basic concepts

Some concepts.

Positions on options can be long or short.

As we have seen in the introduction, the buyer of an option has the right to buy (call) or sell (put) a specified amount of asset (real or financial) at a fixed price on or before a fixed date. The buyer of an option is said to be long. As the losses are limited to the premium paid, the option buyer doesn't need to give any guarantee (called margin requirements).

But when an investor purchase an option, you have on the other side somebody who sells the option. The seller receive the premium paid by the buyer but the right to buy or sell becomes for the seller an obligation to sell or buy. The seller of an option is said to be short. To cover their obligations, sellers have to provide a guarantee. This guarantee is called margin requirements. 

The way to compute the margin requirements depends of the market where the option is traded and of your financial institution. This margin is often the market value of the option plus an amount depending of the volatility and the difference between the strike price and the market price of the underlying asset. This margin can be covered by a cash deposit or by a pledge on an existing portfolio (see leverage techniques).

We will classify strategies into two main categories (themselves divided into two sub categories):

• Basic strategies where only one option is involved.

  • Limited risk position.

  • Unlimited risk position.

• Advanced strategies with more than one option.

  • Limited risk position.

  • Unlimited risk position.

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