There are two types of options - CALLS and PUTS. The buyer of a CALL option
acquires the right, but not the obligation, to buy the underlying asset at a
fixed price. Call options generally rise in value if the price of the
underlying asset rises. The buyer of a PUT option acquires the right, but
not the obligation to sell the underlying asset at a fixed price. Put
options generally rise in value if the price of the underlying asset falls.
The buying of options involves limited risk - that is to say you cannot lose
any more than the premium paid at outset.
It is also possible for you to write or sell options. The writing of call
options, although having a wide range of uses, is a potentially high-risk
strategy requiring a high degree of product knowledge. Since exercise can
involve the writer in a substantial financial commitment, option writers are
required to deposit margin with the broker to ensure the obligation of the
contract can be met in full if required.
An option can be granted over many assets - including soft and agricultural
commodities, bonds, shares and share indices. Equity options are financial
instruments who's price movements are derived from the price movements of an
underlying share price or index and hold a host of investment opportunities
for you as a private investor. Whilst options on individual equities allow
investors to gain exposure to specific shares, index options allow investors
to gain exposure to the UK stockmarket in one transaction.
A futures contract is a standardised contract to buy or sell a specified
asset at a pre-agreed price on a pre-agreed date. It is akin to a cash
transaction with the final element - settlement - being deferred.
Nowadays most futures contracts are transacted on a recognised exchange
using a broker, with the quality and quantity of the underlying asset
standardised. Additionally, the exchange specifies the dates (or range of
dates) within which deals must be settled, so assisting trading and ensuring
liquidity. Futures contracts that are not exchange traded are known as 'over
the counter' or 'OTC' products.