hello welcome to my youtube channel my name is Patrick Boyle and I teach the derivative
selective at King's College London and Queen Mary University of London and today I'm are
going to talk to you about options were going to learn about options as derivative so what
is an option an option is a derivative financial instrument so as a derivative that means it's
a financial instrument that derives its price from another financial instrument that we
call the underlying and so an option is a derivative financial instrument that specifies
a contract between two parties for a future transaction on an asset add a reference price
the buyer of the option gets the right but not the obligation to engage in that transaction
well the seller incurs the corresponding obligation to fulfill the transaction so what does that
mean so we just in our prior videos we've covered the futures and we're we're on two
options now and the big difference here would with a futures contract we've agreed to exchange
at an agreed-upon price at an agreed time and so it option sounds an awful lot like
that but the big difference is that one of the two parties in this options contract actually
gets to choose whether that transaction goes ahead or not so what the future definitely
goes ahead would an option one of the two people actually as a choice they get to make
a decision that they have an option to make a decision at some point in time as to whether
they wish that transaction to go ahead or not now it should be fairly obvious that the
only reason they would decide for that transaction to go ahead is if the price is moved in a
direction that is favorable to them so as you can see there the buyer of that option
actually has quite an advantage over the seller of the option okay it's not like the future
where they both just have different points of view about the direct the market in this
case they have different points of view but the buyer actually has a significant advantage
in that they get to make this decision now the downside is of course that in order because
one side of this transaction is significantly better than the other the buyer of the option
has to pay something to the seller of the option right because if you were if you wouldn't
enter a transaction like that the seller without being compensated for it it only makes sense
to charge an amount of money so that is what an option is a derivative that specifies a
contracts it's a legal contract once again much like a future was a contract between
two parties so there's always a buyer and seller of every option for future transaction
on an asset at a reference price and we call that reference price the strike price and
that can really be any price that the two parties agree upon okay so that's what an
option is but now we've got two main types of option we've got a call option and we've
got a PUD option okay so we'll start with a call option a call option the buyer of a
call option has the right but not the obligation and you're gonna hear that term quite a bit
in this video and in any of our videos about options - right but not the obligation so
the buyer of a call option has the right but not the obligation to buy an agreed quantity
of a particular underlying from the seller of the option at a certain time which we call
the expiration for a certain price which we call the strike price the seller of the call
option is obliged to sell the underlying should the buyer so decide the buyer pays a fee which
we call a premium for this right so that's all it is a call option gives you the right
to buy the underlying from the seller of the call now our next option after that is a put
option and the definition of put option is essentially it's sort of word-for-word the
same as a call option except that the buyer of a put option has the right but not the
obligation to sell the asset at the strike price by the future day and the seller has
the obligation to buy the acid if the buyer exercises the option and so once again with
the put option we've got premium the buyer of this option pays a premium for this right
and so what does that mean well there's two types of options out there there's a call
and there's a pot and you can choose to either be a buyer or a seller of either option so
if you're a buyer of a call option you're bullish right and bullish means that you expect
the price of the underlying to go up if you're the seller of that call option you're bearish
you're expecting the price of the underlying to either stay the same or possibly fall but
you're not expecting a rise in the price so that's a call option and a put option is sort
of the opposite where the buyer of a put option is bearish they're paying a premium and they
expect the price of the underlying to fall and they will make money based on that so
a bear is someone who expects the price to fall and then we've got the seller of that
put option is neutral or bullish they're hoping that the price will either stay the same or
possibly rise a little bit but they they're not expecting or they're not they're hoping
that it does not fall and so that is our two types of options so just to be very clear
about it there's just two types of options this calls and puts and then you can be a
buyer or a seller of either those and for every buyer there is a seller so if you buy
a call option there's someone who's selling it to you and that's a something that is agreed
upon by both parties because they have opposite point of view points of view know or find
the little breakdown of options we'll talk about is the difference between American and
European option so an American option is an option that can be exercised at any time up
to and including the contracts expiration date so Americans let's just say Americans
they love freedom and they want the freedom to exercise their options whenever they want
to European options are options that can be exercised only on expiration date so there's
just one point when you get to make that decision with a European option now just to be clear
when we call them American European options that's just a name they have it doesn't mean
that one is more popular in one part of the world than than the other American options
are actually the most commonly traded globally because it's not just Americans everyone likes
freedom and European options are the easiest ones to price because there's just that one
date when a decision gets made rather rather than at any point over the life of the option
and some when we move on to pricing options you'll see how the pricing is different now
just one point we'll touch on is to hopefully it's obvious to you that if you've got two
options that are identical except that one is American and one is European hopefully
it's obvious to you that the American option will be more expensive than the European option
and that's just because it has an extra feature and whenever something has an extra feature
it costs a little bit more so that is that is our first video and introduction to options
and we're gonna have a bunch of other videos following up on this talk to you later have
a great day bye