1. An option is a contract giving one party the right but not the obligation to buy or sell an underlying asset at an agreed price, on or before a specified date. The purchaser/holder of the option can either exercise their right or let it lapse.

A call option(看漲期權) gives its holder the right to buy the underlying asset, whereas, a put option (看跌期權) gives its holder the right to sell the underlying asset.

2. The premium is the amount the purchaser of the option must pay to buy the option. It is also referred to as the price of the option.

The writer is the seller of an option who receives the premium.

European style options: can only be exercised on the expiry date.

American/US style options: can be exercised at any time until the expiry date.

3. London International Financial Futures and Options Exchange:

Price transparency/liquidity (resold)/standardized/ limited number of underlying assets/

Over the Counter (OTC) options:

These are available from banks via individual negotiation, the basic features are tailored to the purchaser’s specified requirements/for any size, exercise price, expiry date/expiry date can be any time up to five years ahead/ usually not transferable / non-negotiable(cannot be resold)-liquidity problem

Options can be used for either speculation or hedging.

Option collar

This would involve simultaneously buying puts and selling calls. To some degree the premium received from selling calls will offset the premium paid from buying puts, hence reducing the cost of establishing the hedge.

4. Call option intrinsic value at time t＝The underlying stock’s current price－Call strike price

Put option intrinsic value at time t＝The put strike price－Underlying stock’s current price

If the intrinsic value is positive, the option is in the money (ITM);

If the intrinsic value is zero, the option is at the money (ATM);

If the intrinsic value is negative, the option is out of the money (OTM).

Total value of an option:

Premium＝Intrinsic value ＋Time value

There are three components of the time value:

-Time to expiry

-Expected volatility (standard deviation) of the underlying assets

-The level of interest rates