Different Styles of Options

Different styles of options include European, American, Bermudan, Barrier, Exotic and Vanilla options (a vanilla option being any option that is not exotic).

American and European options

European options may only be exercised on their expiration date, while American options can be exercised on or before that date. American options expire on the third Saturday of every month and are closed for trading the Friday before, while European ones expire the third Friday of every month and are closed for trading on the Thursday before.

For both styles, the pay-off is calculated as:

The maximum of the strike price minus the spot price or zero, for a call

The maximum of the spot price minus strike price or zero, for a put

Where an American and European option are otherwise identical (having the same strike price, etc.), the American one will be worth at least as much as the European one. If it is worth more, the difference in value can be used to determine whether or not it should be exercised before the expiration date.

Options contracts traded on exchanges are mainly American, whereas options traded over the counter are mainly European.

Bermudan options

A Bermudan option may be exercised on specific dates on or before expiration. It is half-way between European (which allow exercise at one time) and American (which allow exercise at any time) options. Most exotic interest rate options are Bermudan style options.

Barrier options

Barrier options can only be exercised once the underlying asset’s price has passed a certain level, or barrier. Barriers are always cheaper than non-barriers, and were created to allow investors to hedge with options without having to pay as high a premium.

The two types of barrier options are ‘in’ and ‘out’ options – ‘in’ options start their lives worthless and become active when a set barrier is reached, while ‘out’ options start their lives active and become worthless once a barrier is broken. Both types can be divided into two more categories – up-and-out or down-and-out, or up-and-in and down-and-in.

• Up-and-out: the spot price starts below the barrier and has to rise for the option to expire

• Down-and-out: the spot price starts above the barrier level and has to fall for the option to expire

• Up-and-in: the spot price starts below the barrier level and has to rise for the option to become activated

• Down-and-in: the spot price starts above the barrier level and has to fall for the option to become activated

Exotic options

Exotic options can have both standard and non-standard exercise styles, as well as standard and non-standard pay-off calculations.

Exotics with standard exercise styles can be exercised either in the European or American style, the only difference being the calculation of their pay-off value:

• A cross option is on an asset in one currency with a strike price denominated in another currency – one example would be IBM, which is denominated in US dollars. Trading on IBM in Japan would involve converting the pay-off into Japanese Yen, meaning the pricing of these options needs to take forex volatility into account. A quanto option is another version of this, but the exchange rate is set from the outset of the trade.

• An exchange option is the right to exchange one asset for another.

• A basket option is on the weighted average of several underlying assets. A rainbow option is a basket option where the weighting depends on the financial performance of each asset.

• A low exercise price option is a European call option with a low exercise price of USD0.01.

Some exotic options can use the same pay-off values as American and European options, but the early exercise can occur differently:

• A Canary option has exercise styles between European options and Bermudan options – typically the holder can exercise the option at quarterly dates, but not before a set time period (usually 12 months) has passed.

• A capped-style option has a profit cap written into the contract – capped-style options are automatically exercised when the underlying asset reaches that price.

• A compound option is an option on an option, giving the holder two separate exercise dates and decisions.

• A shout option allows the holder two exercise dates – before the expiration date the holder can ‘shout’ to the seller that they want to lock-in the current price, and if this gives them a better deal than the ay-off at maturity they can use the shout date price rather than the price at maturity to calculate the pay-off.

• A swing option gives the holder the right to exercise only one call or put on any one of a number of specified exercise dates, with penalties imposed with the holder has a net volume higher or lower than specified upper or lower limits.

Other exotics have pay-offs that are calculated quite differently, alongside their exercise styles varying:

• A look-back option is where the holder has the right to buy or sell an underlying asset at its lowest or highest price over a preceding period, while a Russian option is a type of look-back option that has an infinite preceding period.

• An Asian (or average) option’s payoff is determined by the average price of the underlying asset over a predetermined period of time.

• A game (or Israeli) option is where the writer can cancel the option offered, but must pay that point’s pay-off as well as a penalty fee.

• A cumulative Parisian option has a pay-off dependent on the total amount of time the underlying asset value is above or below a certain strike price, while a standard Parisian option is dependent on the maximum amount of time the underlying asset value spent consecutively above or below a strike price.

• A re-option occurs when a contract has expired without having been exercised, and the owner of the underlying asset may then re-option the asset.

• A binary (or digital) option pays a fixed amount, or nothing at all, depending on the price of the underlying asset at maturity.

• A forward start option is an option with a strike price to be determined in the future, and a cliquet option is a sequence of forward starts.

Options can be a valuable form of insurance in any trading portfolio. Discover more about options trading online today.

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Do You Need a Bank Account?

People who don’t maintain bank accounts keep their cash in sock drawers or under their mattresses. But how safe is your cash in those sack drawers or under your mattress? Because of cash’s vulnerability to theft, keeping them in a more secure place, like the bank, is better – for the sake of peace of mind.

Let me convince you how important opening an account with the bank is.

Bank accounts keep your money safe. Keeping large amounts of cash in unsecure places will more likely cause you to fall victim to fraud or theft.

Cash kept in sock drawers or under the mattress do not earn interest. Regardless of the rate of interest, a cash to spare will earn you a return without exerting any effort.

Cash readily available for use, like those kept in sock drawers and under the mattress make you prone to unnecessary and unplanned expenses.

Online transactions like PayPal require you to have a bank account. Your account will make receiving cash and paying expenses online more convenient.

Managing money in bank accounts is a lot easier. Online banking, which has become a popular feature of many accounts today, makes checking balances, setting up orders, and transferring money between accounts fast and easy.

Most lending institutions require the use of bank accounts to establish a borrower’s credit record. In fact, lenders use your banking information in making decisions on whether to extend credit to you or not.

Bank accounts provide access to bank services like check books, ATM cards, credit cards, and other loans.

You may also want to consider what kind of account is more appropriate for you. The most common would be the checking account and the savings account.

A current account is also called as checking account. Aside from issuing checks for withdrawals, current accounts can also accommodate deposits (including paychecks); allow withdrawals either directly at the bank or through bank-issued debit cards; and allow transfer of funds to the holder’s other accounts. Basically, current account holders can add and deduct money whenever they please without any hassle at all.

Saving accounts, on the other hand, are opened primarily for the purpose of “saving” money. As its name suggests, savings account are maintained to save some amount to defray unplanned and emergency financial requirements. Depending on the bank, charges may be imposed for withdrawals made to the account.

As soon as you are able to decide which kind of bank account would work best for you, shop around to find which banking institution offers the best deals for you. There are a lot of packages and features that would make banking easy for you.

Jason O. Joaquin is an accountant and freelance business consultant. Currently, he is employed as Internal Audit Manager in a group of companies in southern Philippines.