Part 27: Options

In financial markets, you will often hear the term “options.” Options are a type of derivative instrument widely used by both investors and companies. In this article, we will discuss what an option is, the purposes it serves, and how it works.

What is an option?

An option is a contract that gives the investor the right, but not the obligation, to buy or sell an asset at a specific price in the future. 

The two main types of options are:

• Call option – gives the right to buy an asset at a predetermined price.
• Put option – gives the right to sell an asset at a predetermined price.

Options can be used both for risk management and for profiting from price movements.

Options are complex and risky instruments. They are suitable for experienced investors. However, understanding them is important for gaining a complete picture of investments and financial markets.

Why are options used?

Options are mainly used for two purposes:

• Risk management (hedging)

An option can be viewed as a form of insurance.

Example: An investor owns shares and is concerned that their price might fall. He can buy a put option, which gives him the right to sell the shares at a fixed price. If the price does fall, the investor will be able to sell the shares at the pre-agreed higher price and avoid a large loss.

• Profit from price movements

An investor can try to predict price changes and profit from it without owning the underlying asset.

Example: An investor believes that the share price of company “ABC” will rise. He pays $10 for a call option that gives him the right to buy one share at $100. If the market price rises to $120, he can buy the share at $100 and immediately sell it at $120, making a profit. If the price does not rise and stays below $100, the investor will simply not exercise the option. His loss will be limited to the $10 he paid for the option (the premium).

It should also be noted that options can be sold on the market before they expire.

Key features of options

• Right, but not obligation | An option gives the investor the freedom to choose. If the market price is not favorable, they can simply choose not to use their right.
• Premium | When purchasing an option, the investor pays a predetermined amount upfront. If they choose not to exercise the option, that amount becomes their loss.

Apricot Capital is regulated by the Central Bank of Armenia.

The examples in this text are for illustrative purposes only. This does not constitute investment advice or a recommendation to buy or sell any specific investment instrument. The past performance mentioned in this text is not indicative of future results.