By definition, If the exercise price of a call option (or Put option) is same as the present market (or spot) price of the underlying stock (or index), then the call or put option is said to be At-the-money option. In this case the buyer has the right to buy the options at $30 per share (which is the strike price of the option), although the market price of Microsoft stock is same ($30).
Same thing goes for the buyer of the Put Option, but on the reverse side of the payoff function. Please note that moneyness of options keep changing as the time passes by, and as the spot price of underlying keeps changing. As Foreign Exchange (Forex) markets comprise the largest volume of monetary values traded on a daily basis when compared to every other financial market and asset class, it is no coincidence that one such popular method of trading currencies include forex options trading – also known as currency trading options.
An option is a right but not an obligation to buy or sell an underlying asset class at a specified strike-price, and the right of which can be bought or sold either on an exchange (exchange-traded) or in the over-the-counter (OTC) markets (off-exchange).
The owner of an option contract can exercise this right to buy or sell, up until expiration of the contract at which point the option expires worthless if not exercised.
Although the share of forex options trading overall doesn’t dominate the majority of FX market volumes, it still represents a meaningful share of trading and thus can be a viable instrument and method to consider when investing or trading foreign exchange.
Just like options on nearly any financial instrument, in foreign exchange, call options involve the right to buy – and put options convey the right to sell  -an underlying instrument at a specified exchange rate, and premiums are paid by buyers and earned by sellers when carrying out forex options trading.
Options contract are typically for a pre-determined quantity of an underlying asset, and will vary depending on the contract specifications of the broker or exchange operator, as well as the specific instrument being traded, such as an underlying currency pair.
Options are divided into Puts and Calls, whereas a “Call” is the right to buy an underlying asset at a specified strike-price, and where a “Put” is the right to sell an underlying asset at a specified strike-price. However, Buying or Selling either of these option types can have very different consequences.
Moreover, each option contract conveys a quantity of the underlying asset that will be traded if the contract is exercised by the party that has the right to exercise their option. In the event the buyer of this option exercised the contract, the seller would technically need to deliver the underlying EUROS in exchange for the US Dollars the seller was paying to purchase the 100,000 Euros at the underlying strike price. Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. A call option is a financial derivative that gives the holder the right (but not the obligation) to buy the underlying stock at a pre-specified price (the strike price) at any time up to the day when the option expires (the expiration date). In the example payoff above, the call pays nothing up to the strike price at 15, after which the option is in the money and will increase in value as the underlying stock continues to advance. The long call option is considered to be limited risk, because you can only lose the full amount of what you put in. TweetPut options are basically the opposite of call options, when you purchase a call option somebody else has taken out a put option to cover the other side to your trade.
If, however, the share price never drops below the strike price (in this case, $50), then you would not exercise the option (because selling a stock to Trader B at $50 would cost you more than it would cost to buy it). Using put options to hedge your investment portfolio is the perfect strategy; most professional hedge fund manager’s this strategy to hedge open positions.
Covered Puts – The covered put strategy is a hedging strategy that should be used in a bearish market. Basically you short shares in an underlying asset and then sell put options against them in order to profit from a bearish move. Profit for the covered put option strategy is limited and maximum gain is equal to the premiums received for the options sold.
Naked Puts – Naked puts, sometimes called uncovered puts are put options where the seller does not have a position in the underlying stock.
Naked puts are considered to be very risky and your broker may not allow you to trade them or require much higher margin requirements. If you’re new to options you need to be careful which broker you choose, options trading is very risky and can result in significant losses for the unwary. For this reason we recommend rookies start trading with either optionsXpress or OptionsHouse, since both brokers offer excellent support and training as well as intuitive platforms and reasonable commissions. Successful options’ trading is difficult and will require a small amount of dedication on your part, don’t make the mistake of hampering your success by using a broker that doesn’t have a vested interest in you succeeding.
In this series of articles, we will cover the various "Moneyness of Options" - basically In the Money Options, At the money Options and Out of the Money options. Going by the nomenclature explanation, the buyer of this call option has the right to buy the stock at a price which at present is same as the price he would have to pay to buy the stock in the stock market, so he is at a no profit no loss position, hence he is just "at-the-money". Hence, this situation is neither profitable nor loss-making to the Buyer, so it is called At the Money Call Option.
As can be seen in the following payoff chart, the call option is neither profitable nor loss making to the buyer. Taking the same example above, we can again check the following pay off function for a Put option, where the strike price is same as the underlying's spot price. Although the stike price of option usually remains contant during the lifetime (unless there is some corporate action), but something which is in the money today, may be out of money tomorrow. In addition, as will be revealed below, sellers of options, known as writing options, carries its own set of differences when compared to buying options, and understanding currency trading options can be a valuable tool in a forex trader’s portfolio. The way that such measurements are made depends also on what type of option position is being taken, whether a Call is being bought or sold, or whether a Put is being bought or sold, as will be described below. For example, buying a call gives the buyer the right to buy at the underlying strike-price of the option, whereas selling a call requires that the seller must be able to deliver the underlying asset and sell it to the buyer at the underlying strike-price if the buyer decides to exercise their option prior to expiration. The option holder is said to exercise the option if he exercises his right to buy or sell the underlying.
X has bought the Microsoft call option at $2 and the Microsoft call option has a strike price of 30 and expiry as 30-June-2010.
If exercise is allowed only at the option’s maturity then the option is said to be European-style. As seen above, the position is neither profitable nor loss making to the Buyer of the Put option, hence "At the Money".
If exercise is allowed at any point during the life of the option it is said to be American-style. So let’s take a look at a typical put option trade first, then we’ll look at ways to implement them into your trading strategy.


If the price of XYZ stock falls to $40 a share right before expiration, you can then exercise the put by buying 100 shares for $4,000 from the market, then sell them to Trader B for $5,000.
The put option premium paid to trader B for buying the contract of 100 shares at $5 per share, excluding commissions = $500 (R).
If it can be exercised on a number of pre-determined dates it is said to be a Bermudan or Atlantic option. In exchange for this right, the buyer of most types of option makes an upfront payment, the premium. The level of this premium is not straightforward to calculate but depends on, among other things, the option’s payoff structure and maturity, the level of interest rates and the volatility of the underlying.
What distinguishes options from other financial instruments is the asymmetric payments they generate. Options allow their holders to profit when the price of the underlying moves in their favour while limiting downside to the premium paid. These are options whose payoffs are continuous, whose strike prices are fixed, which exist in the same form throughout their maturity and for which a standard upfront premium is payable. It also includes a number of combinations of standard options (known as spreads) which are commonly used to create more complex payoff profiles tailored to more specific views on the part of the buyers and sellers. More complex options fall into a number of different types and are dealt with in the following chapters.
Definitions Back {forward} spread (i) Any option spread where more options are purchased {sold} than sold {purchased}.
Box [spread] Generally the term box position refers to any offsetting spread positions; for example, the combination of bull and bear spreads.
Another example is the combination of a horizontal or calendar call spread and a calendar put spread with both spreads having the same expiration dates on their long and short positions. These types of spread positions are used to capture the value in mispriced options while hedging against market risk or, alternatively, are used to tie up or free up cash. A long butterfly might be long an option (put or call) at 40, short two at 60 and long one at 80. Call {put} option An option that grants the holder the right but not the obligation to buy a pre-agreed amount of a specified underlying at a pre-determined price or rate. The buyer of a call is expressing a bullish view on the underlying and also implicitly, since he is long an option, believes either that volatility will rise or at least that it will not fall. In a foreign exchange option, since the option is to exchange one currency for another, all options are call options on one currency and, by definition, put options on the other currency. Call {put} spread An option spread involving the simultaneous purchase and sale of call {put} options on the same underlying either with different strike prices or maturities. So a bull {bear} call spread is the purchase of a call option with one exercise price and the sale of a call with a higher {lower} exercise price both generally with the same expiration.
And a bull {bear} put spread is the purchase of a put option with one exercise price and the sale of a put with a higher {lower} exercise price, both generally with the same expiration. A caplet {floorlet} can be viewed either as a call {put} on an interest rate index or a put {call} on an interest futures contract or zero coupon bond. A quanto cap is one option or a series of options whose payout is based upon a reference (foreign) Libor exceeding (cap) or falling below (floor) an absolute strike rate or spread with respect to the base (domestic) Libor. Variants include: The rate differential option is a quanto cap or floor on the foreign interest rate or domestic currency payment stream in a differential swap. For example, a borrower of Swiss francs paying three-month dollar Libor plus a spread in exchange for three-month Swiss franc Libor under a differential swap could cap his absolute rate payment.
The spread differential option is a quanto cap whose buyer receives the spread between two interest rates in different currencies minus a strike spread, with the payment denominated in his required currency. Capped call {floored put} An option with both a strike price and an in-the-money cap {floor} strike. If the underlying hits the cap {floor} strike then the option is automatically exercised for its intrinsic value. It is different from a call {put} spread in that the cap {floor} is locked in if ever the trigger is hit regardless of subsequent movements in the underlying. These instruments can be used as one element of a collar or risk reversal strategy in which, as soon as the underlying trades through the cap strike, the short option explodes (expires) and the long option pays out. Because the automatic exercise locks in the intrinsic value of the option, these options have a similar risk profile to vanilla options.
A long condor can be constructed by, for example, buying a call struck at 40, selling a call struck at 60, selling another call struck at 70, and buying a call struck at 80. The short condor sells the lowest strike call, buys the two higher strike price calls and sells the highest strike price call.
Conversion [arbitrage] An arbitrage trade so called because it can be used by the holder of a put to alter his position to a call or vice versa. A conversion, also known as a long option box, is the purchase of the underlying or future, purchase of a put and sale of a call with the same exercise price and expiration date.
This converts a put to a call and creates a short synthetic futures position hedged by a position in the underlying or future. The opposite is known as a reversal or short option box or reverse conversion and is the purchase of a call, sale of a put with the same exercise price and expiration and sale of the underlying or future. If a put is overvalued (or if the put is fairly valued but the call is undervalued), a riskless profit can be made by executing the reversal. If the call is overvalued (or the call is fairly valued but the put is undervalued), the riskless profit is generated by selling the call, buying the put and buying the underlying or a future.
Corridor A call spread constructed from the purchase of an interest rate cap at one level and sale of another at a higher level. The holder of the corridor is protected against rate rises between the strikes of the two calls.
Diagonal spread An option spread in which the holder is short the same type (call or put) of options of one maturity and strike price and long options of a different maturity and different strike price.
A diagonal bull spread is the sale of a shorter maturity option and purchase of a longer maturity, lower strike price option. A diagonal bear spread is the purchase of a longer maturity option and sale of a shorter maturity, lower strike price option.


Fraption An option on an FRA giving the holder the right but not the obligation to purchase an FRA at a predetermined strike. Participating option An option which changes the rate of participation in a price or rate movement once the strike price has been reached.
Example A participating call option on the FTSE-100 stock index might give 100% participation from a strike at-the-money up to the point at which the index has moved up 10%. Effectively the option holder has sold a call at that level on half the notional principal of the original call. Horizontal spread A generic name for the simultaneous purchase of one type of option (call or put) and sale of the same type of option with the same strike price but a different maturity. Usually used specifically of the simultaneous sale of an option with a nearby expiry date and the purchase of an option with a later expiry date, both with the same strike price. For example, a ratio bull spread is the simultaneous purchase of in- or at-the-money options and sale of a larger quantity of out-of-the-money options.
And a call ratio forward spread is the simultaneous purchase of at- or in-the-money calls and sale of a larger number of out-of-the-money calls. If however it rises beyond the strike of the short calls so far that the intrinsic value from the long position is overwhelmed, the position can lose value, The potential losses on the position are unlimited. Risk reversal The simultaneous purchase of an out-of-the-money call {put} and sale of an out-of-the-money put {call} usually with zero upfront premium. To a trader, the term means more specifically the purchase of a less than 50% delta (?) call {put} financed by the sale of a similar delta put {call} for zero upfront cost.
The options being bought and sold will typically have the same notional size and pre-specified maturity and the deltas will typically be set to 25%.
According to Black-Scholes the purchase and sale of options with similar deltas (and so out-of-the-money forward to the same extent) should be zero cost. In practice the market favours one side versus the other in the simplest case the implied volatilities of out-of-the-money puts and calls of the same strike and maturity are different and the extra cost of the favoured side is commonly known as the risk reversal spread.
When positive, it indicates that calls are more favoured by the market than puts and that the market is more likely to rally significantly than fall (and vice versa when it is negative). At expiry if the spot is above 1.0477 then further losses on the underlying position are hedged by the purchased option.
Seagull A ratio spread comprising the purchase of a call spread and the sale of a put with a strike below that of the calls, or vice versa.
Straddle A long straddle is the purchase of a put option and a call option on the same underlying with the same strike price and the same time to expiry. The position (which can also be constructed from two long puts and a long position in the underlying or two long calls and a short position in the underlying) will make money if volatility is high. A short straddle is the sale of a put option and a call option on the same underlying with the same strike price and the same maturity.
Strangle Similar to a straddle except that the strike of the call lies above the strike of the put. A long {short} strangle is the purchase {sale} of a put option and a call option on the same underlying with the same expiry date but with different strike prices. The short strangle generates less premium than the straddle because options sold are out-of-the-money and so cheaper.
Straddles and strangles involve combinations of two options, which differentiates them from, say, butterflies, which involve combinations of four options, and can in fact be constructed by combining a strangle and short straddle and vice versa.
This can be considered an option to buy or sell a fixed-rate bond versus selling or buying a Libor flat floating-rate note. A payer(‘s) swaption is an option that gives the buyer the right but not the obligation to enter into an interest rate swap paying fixed and receiving floating.
It is also called a put swaption as it is analogous to a put on a fixed-rate instrument (that is, an option to issue a bond).
A receiver(‘s) swaption is an option giving the holder the right to receive fixed rate under an interest rate swap.
As it is analogous to having a call option on a fixed-rate bond, it is also known as a call swaption. Typically, the option period is for a year or less on swap maturities of between three and ten years. If swap rates rise to 8.00%, the option would be exercised and a cash payment made to the swaption buyer. They are also used, like forward start swaps, to monetize call and put options embedded in callable and puttable bonds. Example An investor seeks the better performing of a EUR fixed-rate asset and a USD fixed-rate asset. The borrower gets cheaper funding regardless of option exercise, the investor gains the required exposure. The swaption is more economical than the purchase of an FX option and two interest rate options, unless the implied correlation between them is zero.
Table-top A ratio spread in which the purchase of an option is paid for by sales of the same option at two different strike prices.
For example, the purchase of one call option with a strike of 40 and the sale of one call struck at 60 and another struck at 80. Vertical spread A generic term used to describe the simultaneous sale of one type of option (call or put) and purchase of the same type of option with the same maturity but a different strike price. Warrant An option in the form of a listed security rather than an over-the-counter contract. Warrants are available on all the asset classes used as the underlying in option contracts.
Fetherston at the University of Albama put this together at some point in time – a mix of teaching notes, core concepts, a glossary and a 109 page handy desk reference that you would end up referring to if you work with derivatives in any shape and form.I stumbled across this resource about 5 years ago and it had been stewing invisibly in one of the many resource folders I have on my hard drive.



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