The price of an option derives from the difference between the reference price a nd the value of the underlying

asset (commonly a stock, a bond, a currency or a futures contract) plus a premium based on the time remaining until the expiratio n of the option The reference price at which the underlying asset may be traded is called the st rike price or exercise price The process of activating an option and thereby trading the underlying at the ag reed-upon price is referred to as exercising it Most options have an expiration date. If the option is not exercised by the expi ration date, it becomes void and worthless. In return for assuming the obligation, called writing the option, the originator of the option collects a payment, the premium, from the buyer. The writer of an option must make good on delivering (or receiving) the underlying asset or its cash equivalent, if the option is exercised. An option can usually be sold by its original buyer to another party. Many optio ns are created in standardized form and traded on an anonymous options exchange among the general public, while other over-the-counter options are customized ad hoc to the desires of the buyer, usually by an investment bank. ========================================================================== Contract specificationsEvery financial option is a contract between the two coun terparties with the terms of the option specified in a term sheet. Option contra cts may be quite complicated; however, at minimum, they usually contain the foll owing specifications: whether the option holder has the right to buy (a call option) or the right to s ell (a put option) the quantity and class of the underlying asset(s) (e.g., 100 shares of XYZ Co. B stock) the strike price, also known as the exercise price, which is the price at which the underlying transaction will occur upon exercise the expiration date, or expiry, which is the last date the option can be exercis ed the settlement terms, for instance whether the writer must deliver the actual as set on exercise, or may simply tender the equivalent cash amount the terms by which the option is quoted in the market to convert the quoted pric e into the actual premium the total amount paid by the holder to the writer of t he option ============================================================= Over-the-counterOver-the-counter options (OTC options, also called "dealer optio ns") are traded between two private parties, and are not listed on an exchange. The terms of an OTC option are unrestricted and may be individually tailored to meet any business need. In general, at least one of the counterparties to an OTC option is a well-capitalized institution. Option types commonly traded over the

counter include: 1.interest rate options 2.currency cross rate options, and 3.options on swaps or swaptions. ============================================================= Other option typesAnother important class of options, particularly in the U.S., are employee stock options, which are awarded by a company to their employees as a form of incentive compensation. Other types of options exist in many financia l contracts, for example real estate options are often used to assemble large pa rcels of land, and prepayment options are usually included in mortgage loans. Ho wever, many of the valuation and risk management principles apply across all fin ancial options. ============================================================ Option stylesMain article: Option style Naming conventions are used to help identify properties common to many different types of options. These include: European option an option that may only be exercised on expiration. American option an option that may be exercised on any trading day on or before expiry. Bermudan option an option that may be exercised only on specified dates on or be fore expiration. Barrier option any option with the general characteristic that the underlying se curity's price must pass a certain level or "barrier" before it can be exercised . Exotic option any of a broad category of options that may include complex financ ial structures.[7] Vanilla option any option that is not exotic. ============================================================= http://en.wikipedia.org/wiki/Moneyness http://en.wikipedia.org/wiki/Black-Scholes