Talk:Option (finance)/Archive 1

Option Premiums

Could someone please explain how the options premium is caluclated? Is it always just the difference between the spot price and the forward price? or do financial instos set their own prems depending on sentiment? thanks.

Calculating Option Premiums

Here's a link to the page on it. [1]

Switching option

Hello

could anyone explain what concretly a switching option is and how to calculate the option price?

I had never heard of a switching option and from the red link you can tell we don't have an article on them, but googling for exactly that phrase gives a few good results among the first few including this one, a 26 page pdf paper analyzing the pricing of switchin options. It never gives a clear definition, but notes they are a type of real option. - Taxman ^Talk 05:34, July 18, 2005 (UTC)

Vanilla Option merge

I went ahead and merged the Vanilla Option article into this one. The only trouble is that I couldn't find much in there that I thought was to the point. In any case the original text follows. If anybody wants to put some of this back in, be my guest. Smallbones 05:02, 16 December 2005 (UTC)

In finance, a vanilla option is a type of derivative. Though the term is very widely used throughout financial literature and the financial markets, it lacks a precise definition. Generally speaking a vanilla option is a 'simple' option in some sense. For example, a particular type of option may be described as vanilla if it is well-established in the financial markets and is easy to trade - vanilla options typically have good liquidity at a wide range of strike prices and maturities. The term vanilla option is almost always used in a context where there is a more complex or exotic option being considered. Thus in one context a particular instrument may be considered to be vanilla but exotic in an other. A striking example is the following sequence of instruments, each of which is exotic compared to the previous one in the list but rather vanilla compared to the next:

financial future → interest rate swap → european swaption → bermudan swaption → rollercoaster bermudan swaption.

(Note the first two of these are instruments without optionality, the term vanilla is applied to these too).

Calibration and hedging are key factors in determining which instruments are called vanilla. For example a bermudan swaption may be hedged by a collection of european swaptions. Thus a trader in the bermudan market will likely think of european swaptions as the vanilla. Further a model developed to price bermudan options may be calibrated (i.e. have its parameters chosen) such that the model gives the same prices as those found in the market for european swaptions. That is, the model takes the european prices as given and uses them to determine a price for the more complex bermudan product. Again the term vanilla describes the european swaptions and exotic describes the bermudan.

Even with the above caveats there are instruments almost universally termed vanilla in various markets. In the foreign exchange and stock markets the most vanilla options are european call and put options. In the interest rate market swaps and caps are the vanilla instruments, although the former does not actually involve any optionality. European swaptions are sufficiently liquid to be called vanilla. The credit derivatives market is less mature. Here the three most traded instruments are total return swaps, credit default swaps and credit spread options. These are widely expected to become the mainstream vanilla products of the market in the coming years.

Conversely an exotic option is some instrument that is more complex than the current frame of reference. The term "third generation option" is also used to somewhat frequently - it is not clear exactly which other options would be placed in the first and second generations.

Option Pricing Models

I noted that this section was just taken out. It certainly could use some work. In particular the first sentence seemed a bit ad hoc, and there was little specific info on models. Nevertheless, I think something should be put in its place!

External links

I'm just done a cull of the external links section per the guideline. If there are any that anyone thinks should be included, please discuss it here first. - brenneman^{L} 05:10, 21 March 2006 (UTC)

Capital Structure and Dividend Policy

Hi everyone.

Can someone please help me out here. I've got some questions. They are as follows:

1. How do taxes affect capital structure and dividend policy? 2. How do agency relationships affect capital structure and dividend policy? 3. How can capital structure and dividends be used as signals? 4. How can a company hedge an underlying position using a variety of derivative securities? 5. When should options, be exercised? 6. Comment on empirical tests of asset pricing models and theories of dividend policy and capital structure.

I will be extremely grateful if anyone can help me. I am studying at the University of Reading and I need these answers to enable me write my disertation.

Thank you very much in advance.

Obie. (obiokete@yahoo.com) 03 April 06

Maybe try reading a textbook! 1-3 and 6 have nothing to do with this article

Please also leave my discussion as posted. Perhaps it is a little bit blunt, but the gist is that if you're trying to get the answers for an (undergraduate?) disertation off of an on-line encyclopedia for topics that cover 60% of modern finance, you're really looking in the wrong place - the sooner you find out that you have to read a textbook for these kind of questions, the better. That said, I do think that Wikipedia has lots of information (and some misinformation) on this stuff, but it still comes down to reading it, understanding it, and then writing it on your own. Smallbones 14:30, 5 April 2006 (UTC)

More calls than puts trade

It is generally observed that liquidity for Call options is higher than that of Puts. That is, on any given day, the number of Calls traded is *typically* higher than that of Puts. For example, see - http://nseindia.com/marketinfo/fo/fomwatchsymbol.jsp?key=INFOSYSTCH I wish to know the reason behind this, and the answer may be added here as well. Google search didn't help. If anyone knows the reason behind this, please mail it to me at amu1983 (AT) rediffmail (DOT) C0M

I don't know of any scientific or "logical" explanation of this but you may take it as a "fact" that in all (or almost all) option markets calls are traded more actively than puts. My "explanation" is simply that people are more comfortable with the idea of purchasing something without paying for it (i.e. being long a futures contract) than of selling something that they don't own (i.e. being short a futures contract). This carries over into options in that "buying the right to buy" is just more understandable to most people than "buying the right to sell." In short - limited rationality.

The reason is that most brokers will not allow investors to do anything other than sell covered calls. This decision is due to their desire to reserve the 'right' to trade options to wealthy (they say sophisticated) clients. In order to justify this refusal of access to the public, they use risk arguments like the ones presented here by Ronnotel. This description of risk is wrong, but he refuses to allow any edits. Since most people think the stock market goes 'up', there will be a bigger market to buy the calls than puts. For the buyers there is no downside risk. The premium paid is a known certainty and a sunk cost at the start. There is only unlimited upside.Retail Investor 17:48, 8 November 2006 (UTC)

Retail Investor, I think you are mis-characterizing my comments and actions. First of all, I'm on record as pro-retail investor with official comments I have provided to the SEC. I would be happy to share with you a cite of this off-line. In short, I'm all for the wider use of options by retail investors. Second, I don't really think it's up to me to allow changes to this page - that's done by consensus. I happen to strongly disagree with your view of premium as a sunk cost and I think it's my responsiblity as an editor to argue my viewpoint. Option markets are highly liquid and far more option positions are closed rather than expire - how can you close an option position if you treat the premium as a sunk cost? BTW, I'm all in favor of recent discussion to apply the same margin rules that firms enjoy to customers. I think the current customer margin requirements are ridiculous and are in much need of reform. Ronnotel 19:19, 8 November 2006 (UTC)

Opt as an abbreviation

Hi, can anyone here comment on weather opt is a common (enough an) abbreviation for option? There was recently put up a disambiguation for opt, and I'm not sure if the mention (well, actually not even the page entire) is warranted. --Swift 11:22, 18 May 2006 (UTC)

clearer understanding -- categories

i am new to stock, trading, etc... it would help if you could also include categories similar to those in Futures contract - Who trades Futures.. so like "Who trades Options"

Also, it would be make for better viewing if there was a Risks category (perhaps instead of having to search for the word 'risk' in the browser window) ... or Risks vs Return

Is this reasonable for this kind of thing? Knowsitallnot 08:01, 6 July 2006 (UTC)

Examples

From the top of the front page:

• Film or theatrical producers often buy the right — but not the obligation — to dramatize a specific book or script.

Is this an option? In this situation there is no future exchange to take place at the choice of the holder. This is a straight-up PURCHASE of RIGHTS. The fact that it is a right and not an obligation is coincidental and not related. Discuss before change. --Risce 13:52, 18 July 2006 (UTC)

That is an example of a real option and is definately an option by most definitions. The purchase of rights will only happen at exercise. In fact the rights to produce a film or theatre production are what will be transfered in the future. The option only gives them the option to buy the rights in the future which would entail a negotiated percentage of profits or whatever else is agreed upon. The option therefore has a current price less than actually buying the rights. If the option expires unused, the rights could be purchased by someone else in the future instead. - Taxman ^Talk 15:55, 18 July 2006 (UTC)

Thank you.--Risce 18:13, 20 July 2006 (UTC)

Aristotle and the Thales Option-Tale

The original text by Aristotle says nothing which permits the conclusion that Thales actually bought a call-option. It remains doubtful what the actual arrangement was. The Greek words misthôsamenon and arrabônas, which Aristotle uses, do not permit the conclusion that Thales did not owe the full rent for the olive presses at a later date regardless of the outcome of the harvest.

The Greek word misthoô is commonly translated with to let out for hire, farm out, let. Also the Greek word arrabônas, (arrabôn meaning earnest-money), which Aristotle uses to describe the legal nature of the payment does not give a definite answer regarding what the legal implications of the arrangement of Thales. The assumption is that the lessor could keep the earnest-money as a penalty if the lessee walked away from the contract but this assumption is based on the historically later use of the word arrabôn particularly on the use of the Latin word arra. So unless you equate a contractual penalty with an option-premium the downpayment which Thales paid to the lessors of the olive-presses had no legal similarity with a call-option. In economic terms the arrangemnt by Thales may have been a Real-Option if, and only if the lessor's only recourse was to keep the earnest-money as a penalty. Aside from this the context in which Aristotle reported the story of Thales deals not with financial instruments but with the issue of monopolizing trade.

As is not uncommon we tend to interpret a historical context with our present (legal) understanding were the lessee/buyer foregoes the deposit in the event he does not sign the final contract (jurisdiction pending), but we do not have a truly clear picture regarding the contractual details that Thales agreed upon since Aristotle does not elaborate on the details and the laws at the time Thales lived are poorly understood, if at all. Popeye2 17:18, 5 September 2006 (UTC)

Thales done bit the dust. Smallbones

New Material

The new material, organization, re-write looks pretty good. Some grammer, spelling, mild POV statements should be corrected, and I'll attempt later. I did take out the following which seems extremely subjective. This type of statement might be applied to any model, thus seems to misunderstand the meaning of models.

"Even though there are pricing models, the value of an option is a personal decision, requiring multiple trade offs. As an example, the valuation of stock option calls can involve the comparison of various metrics. The Excel model here [[2]] automates some of there."

Smallbones 09:26, 29 September 2006 (UTC)

Let me respond. It was my input. A huge problem I have with how options are presented to the public is the way they are valued. Everytime, people are told their value IS $XXX. This is always a model value (usually B-S). You may know that a 'model' is a 'model' but the public is left with a statement of fact. It leaves the impressison that THAT IS the value to everyone. But the value to YOU is your personal response to the risk/reward trade off. Depending what your investing objective (see the spreadsheet and discussion on website) there are different metrics that form the base of your decision. Value is subjective in options, just like in stocks. People should have access to the metrics for decision making. By the way those metrics in the spreadsheet come from the options 'Bible'. They are not my person POV. Will people please first look at the spreadsheet and then comment how it is subjective.

Retail Investor 00:56, 2 October 2006 (UTC)

Risks section removed

While I hate to be discouraging, I had to remove the section entitled Risks because it over-simplifies and quite honestly mis-states the risks faced by the buyer of an option. In fact, the buyer of an option faces numerous risks, much more than simply buying the underlier. These risks include:

• Loss of entire premium paid for the option
• Risk that implied volatility in the option will fall
• Risk that the underlier, if it's a stock, changes it's anticipated dividend (can result in unexpected loss)
• If long a call, risk that the underlier becomes hard to borrow, and therefore cannot be sold short as a hedge
• etc.

I think there is room for a section on Risks, but I think it needs to be better sourced before it is included. As a starting point, consider the handbook from the OCC entitled Characteristics and Risks of Standardized Options (link provided in article). Ronnotel 19:38, 19 October 2006 (UTC)

I rewrote it to incorporate your POV that premiums are not a 100% certain, upfront loss. The other risks you list are detailed reasons for losing that really require a textbook. I think anyone actually trading options should read a textbook. This is a good warning.207.102.255.231 17:22, 21 October 2006 (UTC)

As worded, I believe the section is somewhat unencyclopedic. If we are going to have a section on the risks of trading options, then it should explain all of the risks. It sounds like your purpose is to warn retail investors about trading options - I would argue that is not the purpose of this article or Wikipedia in general. Please give me three days to work up some candidate text - until then, as we don't have consensus, I suggest we leave the section out for now. Ronnotel 17:38, 21 October 2006 (UTC)

OK, I've provided some candidate text for the Risks section. My intent is to provide a more thorough overview of the topic. Ronnotel 20:15, 21 October 2006 (UTC)

I would vote to delete all the stuff in the list of 'other risks'. 1) They represent only the different causes for the risk stated in the first paragraph. 2) Readers who don't already know all about options won't understand it.Retail Investor 17:16, 24 October 2006 (UTC)

I can see your point - however as a general encyclopedia, I believe Wikipedia articles on specialist topics such as options should contain detailed information - even if it is not immediately helpful to the non-specialist. I tried to maintain the level of detail that's in line with articles on options elsewhere on WP. Ronnotel 17:30, 24 October 2006 (UTC)

I rewrote the risk because your list of risks is really just a rehash of the attributes determining value. The risk is that the value changes. Quantifying risk as known, limited, and unlimited is more useful.Retail Investor 18:12, 26 October 2006 (UTC)

Fair enough - your rewrite is thoughtful and quite useful. However, I disagree with the lottery ticket analogue. In practice, most options are closed rather than expire. I think it would naive for a trader, even a retail investor, to forego this possibility by regarding the premium as a sunk cost when it quite clearly a tradable asset. Ronnotel 19:00, 26 October 2006 (UTC)

Enough already207.102.255.229 20:03, 26 October 2006 (UTC)

Hmm - you appear to have arbitrarily removed edits that were made in good faith and for which justification was provided. Can you please provide some explanation other than this? Ronnotel 20:11, 26 October 2006 (UTC)

Let me get this staight. You are complaining because someone removes your work? Don't you remember deleting my whole new section, without even replacing it with anything. And deleting everything I have written since within minutes? Retail Investor 01:25, 27 October 2006 (UTC)

I'm not complaining about having my work removed - the whole thing belongs to WP once you hit the Save page. I'm pointing out that you failed to 1) assume good faith on my part, and 2) strive for consensus before making edits. Yes, I removed some of your changes at first but not without engaging you and explaining my point of view. I've made an argument for removing some text - options are highly liquid instruments and I fail to see how it helps the article to characterize premium as a wasted asset. I think that is misleading. Ronnotel 02:49, 27 October 2006 (UTC)

You never bothered to create the section yourself. You did not "remove some of your changes at first". You have deleted every single entry by me and the other guy as soon as it was posted, even without replacement, even after your POV was included. None of your input included our POV. You stated that my entry "oversimplified and misstates" when in fact it covered more ground than your replacement - upside and downside risk. You did not understand until you were told twice, that your perceptions of multiple risks were really just a list of factors deciding value. You think that by referencing a textbook we will think you understand what you are talking about. The POV you use for justifying changes is "I represent Wiki", so you are the sinner. You still don't know the difference between a certainty and a risk. I won't be changing your input. You can stop lurking and get some sleep.Retail Investor 14:19, 27 October 2006 (UTC)

And I think you need to stop taking this so personally. Ronnotel 14:39, 27 October 2006 (UTC)

Screening tools

"External links - remove link spam - there are lots of screening tools out there, why does this one need to be linked?"

I find option screeners to be useful for the wikipedia community. This is one that I use frequently. It's content is related to this topic and provides information that you won't necessarily find on this page. If you don't like the screener I linked to, then find another one and put it there in it's place. But, I do feel like there needs to be one. If you disagree, then please explain.GeneralBob 22:40, 27 October 2006 (UTC)

To be honest, it seems like link spam - and how do you choose one screener above the others? If you feel option screeners are an important topic (which I don't doubt), how about writing an article on option screeners and linking to that? Ronnotel 23:17, 27 October 2006 (UTC)

That might be an option to consider. However, wouldn't that present the same problem as here? Which one(s) do you pick without showing favoritism to one in particular? Do you list all of them? GeneralBob 23:48, 27 October 2006 (UTC)

Well, there are many pages talking about various services, software programs, etc. I think it could start out as just a stub with a favorite link or two, and then let WP handle the rest. What do you think? Ronnotel 01:06, 28 October 2006 (UTC)

Sounds like a plan to me. Although, I've never created a stub before. Can you lend a hand in this area? GeneralBob 02:14, 28 October 2006 (UTC)

OK, I've got a paragraph or two written - why don't you take a look and see what you can add? Ronnotel 12:31, 28 October 2006 (UTC)

Looks good. I'll take a deeper look later this afternoon and see what I can add. GeneralBob 13:47, 28 October 2006 (UTC)

Merge Equity derivative into this page

See Talk:Equity derivative for discussion Ronnotel 21:30, 3 November 2006 (UTC)

Up-side risk

My previous use of the term upside risk was recently deleted and reinstated. Obviously some people are not familiar with the term.

• The term is in common use, although there is some debate. That is why I gave the definition. Do a google search on the term.
• Investors use a presumed rate of return in their calculation of an asset's price. They presume a higher return for equity than for the certainty of t-bills. But there is no guarantee of equity returns. Any actual return that is lower than the presumed rate is a 'loss', because it means too much was paid for the asset. If you demand that the word 'risk' apply only to risk of loss, then this explains what up-side risk is.
• In finance, risk has a meaning that is different from the dictionary definition. Equity risk is measured by the variability of returns (standard deviation) around a mean. The deviations ABOVE the mean are just as much a factor in the measure of risk as the fluctuations BELOW the mean. Both contribute to risk.
• Baked into the price of options is risk, measured by the implied volatility of the underlying asset. Because of arbitrage, the exact same measure of risk is used to price both the puts (downside) and calls (upside) of the stock. Risk is applied to both upsides and downsides.

207.102.255.230 21:19, 14 November 2006 (UTC)

Other financial option contracts

I put in other uses of options to LEAD OFF the story, following my contribution to the Theatrical producer article. Ms. Retail Investor, who maintains an empty talk page, immediately removed it with no explanation. But these types of financial option transactions need to be dealt with at the start for the benefit of innocents who have no idea of the arcane world of options and won't look for "Historical uses of options." which should be at the start anyway not down there. Any thoughts on this? Anybody? JohnClarknew 18:57, 20 November 2006 (UTC)

Silence, so the heck with it, I just made the change with links, and did not touch the body of the rest of the article which is excellent (imho) except at "history". JohnClarknew 21:44, 20 November 2006 (UTC)

I would disgree that other uses of options needs to be described in the lead paragraphs as you have done here. Ronnotel 21:49, 20 November 2006 (UTC)

Suggestion: at the top we add: For options involving real assets such as real estate, intellectual property, etc. see real options. and then revert to the previous text? Ronnotel 22:00, 20 November 2006 (UTC)

The main problem Ronnotel, as I see it, is that the original sin was to claim the article title Option instead of Option (financial instrument). I have, and do, buy options in the stock market, film world and Broadway, and I remember once in property too (but not, so far, for a book). I am thinking of the reader who maybe wants to buy a play or film or book option (most of the entertainment world wants to do this, I know, I live in the middle of Hollywood), and would look where, and then how, to do it, and get lost and discouraged, they would never type out 'Real option, a coined word. Disambiguation won't help them. If you agree, with your WIKI experience (more than mine, I'm sure), then I suggest that the heading description be changed to Option (financial instrument), lose my intro, and the heading for Real options be changed to, simply, Option, where all these others can be introduced and linked. (Also, I think that article needs to be somewhat re-written for clarity.)

Is it possible to bring up pages, and delete and paste under a new heading, or does that do something strange to the system?

Short of that, and if we're stuck with the present problem as it developed, I strongly believe that the current Option article should be left as is. JohnClarknew 23:05, 20 November 2006 (UTC)

I understand your point, however I suspect that there is a consensus among the contributors to this page that the definition of option as a financial instrument outweighs it's usage in terms a real option. I believe the proper WP style in a situation like this is to maintain the commonly accepted definition, while providing disambiguation text for the alternate meaning. Since you are proposing a major change to the sense of the article, I think it would be a good idea to get consensus on this before hand. What do others think? Ronnotel 23:16, 20 November 2006 (UTC)

OK. I hope new contributors will come in. I don't agree that the word option is commonly accepted and first recognized as a market strategy. Even those that do know that meaning, market investors, avoid it as high risk gamble for elite "insiders", and leave it to traders, a clubby circle of professionals. JohnClarknew 01:00, 21 November 2006 (UTC)

Well, I think the page as it is doesn't make a lot of sense - it's primarily about financial options, but the lead paragraph is about real options - very confusing. How about this, turn Option into a disambiguation page, create Option (finance) with the current text, minus your additions to the lead. You can put a link on the disambiguation page to Real options or wherever and include whatever description you like as long as it conforms to WP style. Agreed? Ronnotel 13:46, 21 November 2006 (UTC)

As above, silence = consent - changes have been made. Ronnotel 18:26, 21 November 2006 (UTC)

While I agree with how the article are presently named ... Ronnotel essentially did a cut and paste move of the article (or of a previous version of the article) from Option to Option (finance). All of the edit history for the latter is still associated with the former. Why didn't you just move the article before redirecting Option to the disambiguation page? BTW, the disambiguation page should ultimately reside at Option, rather than at Option (disambiguation). Now some edit history surgery will be needed to merge the edit histories. older ≠ wiser 18:08, 2 December 2006 (UTC)

Hijacking of Dictionary words

The title of this page did get fixed, eventually, but the simple word still got lost somewhere. Because I feel strongly, in principle, about the ease with which common meanings of words in the English language are manipulated in Wikipedia for the benefit of users with a narrow view, I placed the following on the Wikipedia:Village pump (policy) page, and the responses are worth reading:

Somebody writes a specialized article based on a common word, and then claims to own the common word. Dr. Johnson would be horrified. Examples: I'm tired of arguing on their talk pages the merits in favor of Tenure and Option being allowed to retain their common meanings, letting the specialized versions take the hindmost in the shape of a parentheticised word describing the specialty, whatever it is. There should be a tag asking for an admin to either get the page name changed, or have it deleted. Meanwhile, I am sure many users who live outside the U.S. and U.K. are feeling deprived of information they have a right to. At the moment, any attempt to enlighten with an edit at the opening with an explanation that this is not the common usage of the word is reverted by a robocop reciting that Wikipedia is not a dictionary. JohnClarknew 07:04, 2 December 2006 (UTC)

• JohnClarknew 17:47, 2 December 2006 (UTC)

Why do we have two articles Option and Option (finance) that are essentially the same? This is a mess - it can't stay like this. Ronnotel 20:11, 3 December 2006 (UTC)

I reinserted the redirect. John - can you please come up with a description for what you consider the standard defintition for an option - I simply have no idea what you're trying to say. You complained that most people would not accept the financial definition as the common one. So fine, I moved the existing text to Option (finance) and modified the disambiguation page to be more prominent. At first you agreed. However, you are now asserting that somehow that isn't good enough and you've reinstated a non-sensical version onto Option. The text somehow starts talking about everyday options (choices?, decisions? I have no idea what the point is) and then jumps into the nitty gritty of pricing and valuating financial options. It was a complete mismatch. You obviously feel strongly about the semantics of the word and I'm happy to back you up, but you need to be clear in what you are trying to do. I read what was written at the villiage pump and I fail to understand why that should be take as consensus for your most recent edit. What I'm asking for is a concise page for Options that doesn't try to mash whatever your definition is with Option (finance). Ronnotel 15:46, 4 December 2006 (UTC)

The short answer to the question of why there are two articles is because you did a cut and paste move and John later undid the redirect you had placed in one but did not remove the content from the newly created article. I thik Options probably should be a disambiguation page, but this should be done by properly moving the page, not a cut and paste. older ≠ wiser 19:40, 4 December 2006 (UTC)

I think it's something more than that. I believe John has a notion of what the option page should say - and that it shouldn't be tilted towards the description found at Option (finance). That's fine - because what John is describing really has little to do with that topic. Please feel free to perform whatever administrative steps are required - they are beyond my competence. However, my objection is to mixing up some sort of general purpose description of Option and the description found at Option (finance) Ronnotel 20:10, 4 December 2006 (UTC)