Template:M summ Equity Derivatives 2.3

Call

The basic definition of a call option. I am entitled to buy shares from you at a pre-agreed price (Strike Price) on a pre-agreed date (i.e., a European Option) or a any time up to a pre-agreed date (i.e., an American Option). You can also cash settle a Call by paying the positive difference between the prevailing share price on the Exercise Date and the Strike Price.

But what if the difference between the share price and the Strike Price is negative on the Exercise Date? Then you wouldn’t exercise your call option, friend, because you are homo economicus, remember: the modern embodiment of the rational person on the Clapham Omnibus.

At any time where the prevailing share price is above the Strike Price, your option is “in-the-money”. If the share price is below the Strike Price it is “out-of-the-money”. The option has time value though, so just because it it out of the money it doesn’t mean it's worthless. but you wouldn't exercise it while it was out of the money, all the same.

Put

The basic definition of a put option. I am entitled to sell shares to you at a pre-agreed price (Strike Price) on a pre-agreed date (i.e., a European Option) or a any time up to a pre-agreed date (i.e., an American Option). You can also cash settle a put by paying the negative difference between the prevailing Share price on the Exercise Date and the Strike Price.

But what if the difference between the Share price and the Strike Price is positive on the Exercise Date? Then you wouldn’t exercise your put option, friend, because you are homo economicus, remember: the modern embodiment of the rational person on the Clapham Omnibus.

At any time where the prevailing share price is below the Strike Price, your option is “in-the-money”. If the share price is above the Strike Price it is “out-of-the-money”. The option has time value though, so just because it it out of the money it doesn't mean it's worthless.

But you wouldn't exercise it while it was out-of-the-money, all the same.