One of the most significant developments in financial markets in recent years has been the growth of futures, options, and related derivatives markets. These instruments provide payoffs that depend on the values of other assets such as commodity prices, bond and stock Options
A call option gives its holder the right to purchase an asset for a specified price, called the exercise or strike price, on or before a specified expiration date. For example, a February call option on EMC stock with an exercise price of $70 entitles its owner to purchase EMC stock for a price of $70 at any time up to and including the expiration date in February. Each option contract is for the purchase of 100 shares. However, quotations are made on a per-share basis. The holder of the call need not exercise the option; it will be profitable to exercise only if the market value of the asset that may be purchased exceeds the exercise price. When the market price exceeds the exercise price, the optionholder may “call away” the asset for the exercise price and reap a payoff equal to the difference between the stock price and the exercise price. Otherwise, the option will be left unexercised. If not exercised before the expiration date of the contract, the option simply expires and no longer has value. Calls therefore provide greater profits when stock prices increase and thus represent bullish investment vehicles.
In contrast, a put option gives its holder the right to sell an asset for a specified exercise price on or before a specified expiration date. A February put on EMC with an exercise price of $70 thus entitles its owner to sell EMC stock to the put writer at a price of $70 at any time before expiration in February, even if the market price of EMC is lower than $70. Whereas profits on call options increase when the asset increases in value, profits on put options increase when the asset value falls. The put is exercised only if its holder can deliver an asset worth less than the exercise price in return for the exercise price.