What is a listed option?
A listed option, or exchange traded option, is a type of derivative security traded on a registered exchange. Listed options give the holder the right, but not the obligation, to buy or sell a specific amount of the underlying asset at a fixed price on a given date. Unlike OTC options, they have strike prices, expiration dates, settlements and standardized clearances.
Key points to remember
- A listed option is a derivative security traded on a registered exchange with standard exercise prices, expiration dates, settlements and clearing.
- There are two types of options listed, namely the American style and the European style.
- Listed options, both put options and buy options, offer traders the opportunity to speculate on the direction of movement of the underlying security with a much higher level of security.
Understand the options listed
A listed option, also known as an exchange-traded option, is an option offered on a national exchange such as the New York Stock Exchange (NYSE) or the Chicago Board of Trade (CBOT). They cover securities such as common stocks, exchange traded funds (ETFs), stock indices, currencies, fixed income securities and commodities. Unlike warrants, traders can sell or create options on the underlying securities. The secondary market is active, unlike the exchange of warrants.
Many option contracts are sold over the counter (OTC), with the main advantage of complete customization of the conditions. However, this market is not liquid in most situations and presents a higher risk that a party, the buyer or the seller, does not respect the obligations of the agreement.
However, for most investors and traders, the options listed provide a sufficient vehicle with a much higher level of security. The exchange acts as an intermediary, taking the other side of the trade and providing clearing and settlement services, either directly or through a third party.
There are two types of options listed. These styles are American style and European style. The main difference between the two is the date of execution. With American style options, they can be exercised at any time until the expiration date. Conversely, with European style options, they can only be exercised on the expiration date. However, traders and investors can sell their long positions or redeem their short positions at any time to exit the trade before expiration. Most of the options found on the national stock exchanges are American.
Listed options, both put options and buy options, offer traders the opportunity to speculate on the direction of movement of the underlying security, but at a lower initial cost. Option strategies are potentially able to limit risks and rewards, however the underlying security evolves, if at all. For investors, selling or selling options can create a flow of income from the underlying stocks they already own at the expense of limiting the potential profits of the underlying asset itself.
For traders and investors, options also provide a hedging vehicle. For example, a holder of an equity position could also buy put options to protect themselves against a significant downward movement. The low cost of the option contract is essentially an insurance policy.
Warnings for listed options
While the risk for option holders is limited to the amount they paid to buy them, called the premium, the risk for option sellers or writers can be endless. This higher risk is explained by the fact that option sellers have the obligation, and not the right, to sell or buy, as the case may be, the underlying asset at the exercise price.
For example, the holder of a $ 50 call option on the ABC share will exercise this option if the share price rises to $ 70. The option writer sells the security for $ 50, and if he does not already own it, he must go to the open market to buy the shares for $ 70. The net result will be a loss of $ 20, less the amount of the premium received initially for the sale of the option.
Put sellers take a similar risk, the only comfort being that stocks cannot fall below zero. Option buyers take the risk of time. If the price of the underlying stock does not move, the price of the option will naturally decrease as the expiration date approaches. Fortunately, there are option strategies for buyers and sellers using multiple options with similar or different strike prices and expirations to mitigate these risks.