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When trading options, there are a number of key parameters to keep in mind.
Specifically, these are:
Note that these option parameters are used for the calculation of option pricing <link to option pricing> and settlements <link to settlement>.
There are two types of options:
- Call Option: Buy an asset at a strike price
- Put Option: Sell an asset at a strike price
For any given type of option, there are two possible positions:
- Long Option (Option Buyer): Pays an upfront premium but receives settlement if options are ITM
- Short Option (Option Writer/Seller): Receives an upfront premium but pays settlement if options are ITM
Call option buyers receive the right but not the obligation to buy the underlying asset at a predetermined strike price on a predetermined strike date.
Buying call options is useful for traders who expect the price of an asset to rise. The maximum loss a trader can incur is the cost of the premium.
Call option writers take the opposite position of call option buyers. Said another way, they have an obligation to sell the underlying asset to the call option buyer at a predetermined strike price on a predetermined strike date.
Call option writers receive an upfront premium but pay call option buyers if the price of an asset increases beyond the strike price. If the difference in price exceeds the premiums earned, writers may incur a loss.
Writing call options is useful for liquidity providers who expect the price of an asset to decrease or remain stable. It is not a risk-free strategy since losses are technically uncapped.
Put option buyers receive the right but not the obligation to sell the underlying asset at a predetermined strike price on a predetermined strike date.
Put option purchasers expect the price of the underlying asset to decrease. The maximum loss a purchaser can incur is the value of the premium.
Put option writers take the opposite side of put buyers. This means that they have an obligation to buy the underlying asset at a predetermined strike price at a predetermined settlement date.
Put writers receive an upfront premium but will pay settlement to put buyers if the settlement price of the asset is lower than their written strike price at expiration.
Put option writers expect the price of the asset to increase or remain stable. They may incur a loss if the payment for settlement exceeds the value of premiums received.
The underlying is the asset that an option derives its value from. Theoretically, an option can exist for any asset on the market.
If we take the example of $DPX as an underlying, a $DPX call option will allow a user to buy $DPX for a given strike price at a given settlement date.
Contrarily, a $DPX put option would allow a user to sell $DPX for a given strike price at a given settlement date.
In either scenario, the value of both options derive their value from the price of $DPX at settlement - as such, $DPX is said to be the underlying asset.
The Strike Price is the price a user locks in to buy (call) or sell (put) the underlying at settlement date.
Taking the example of a $DPX call option at a $400 strike price, the purchaser will be able to sell $DPX for $400 at settlement regardless of what the actual spot price is. If the spot price at settlement is $450, the call purchaser will profit $50 ($450 - $400) per option purchased. If the settlement price is lower than $400, the option purchaser is not exercised since it would be at a loss (hence it is the option to buy).
Similar logic can be applied for a $DPX put option at a $400 strike price. If the spot price at settlement is $350, the put purchaser will profit $50 ($400 - $350) per option. If the settlement price is greater than $400m, the option is not exercised.
Expiration (used interchangeably with settlement date or epoch) refers to the time and date at which an option can be exercised. Since Dopex uses European-style options, when expiration occurs determines the spot price to be used for the purpose of settlement.
Volatility is the measure of the variance in the price of an asset over a given period of time. Dopex uses a 30-day annualized historical volatility as a proxy for implied volatility for the purpose of option pricing.