VANILLA OPTIONS GENERAL

 

OPTION CONTRACTS:

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Most common contracts are CALLS and PUTS, also referred to generically as “vanilla options”.

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There are two parties to each option contract – The pption buyer and the option seller (or writer).

 

An option Buyer has no obligation to enter into a purchase or sale at expiration of the contract.

 

When an option is exercised by the option buyer, the option seller has the obligation to buy (put writer) or sell (call writer) the underlying.

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Any purchase or sale of the underlying resulting from the option exercise is discretionary to the option buyer but binding to the option seller.

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In exchange for this right, the option buyer pays an upfront amount (the “premium”).

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Listed option contracts settle through exchanges. Otherwise options settle “over the counter” or “OTC”. Institutional dealers act as OTC market makers and counter-parties to both option buyers and sellers. When a listed option is exercised by an option buyer, the contract is assigned by the exchange to an option seller. Call writers must then deliver the underlying and receive the strike price; put writers must deliver cash for the strike amount and receive de underlying. OTC contracts are almost always directly settled with the OTC dealer that originated the contract.