Finance and Financial Markets

Third Edition

by Keith Pilbeam

Chapter 14 - Options

Find an overview and useful learning resources below to accompany Finance and Financial Markets chapter fourteen.

Chapter Introduction

Options are a special type of financial asset that give the holder the right but not the obligation to buy or sell an underlying security at a predetermined price. Options were first traded in Chicago in 1972, and a decade later the London International Financial Futures Exchange (LIFFE) opened. LIFFE is currently the largest options exchange in Europe. Options contracts have proved very attractive for both commodities and financial securities, and among the most popular contracts traded on LIFFE are interest rate, currency and stock-index contracts.

Like futures, options contracts are derivative instruments; that is, the price of the contract is derived from the price of the underlying asset in the cash or spot market. In this chapter we illustrate various types of options contracts covering individual stock options, interest rate options, currency options and stock index options. We shall consider how options contracts can be used for both speculative and hedging purposes. We shall also discuss the economic role that option contracts can fulfil and emphasize the differences between futures and options contracts.

Learning Objectives

In this chapter you will learn about:
  • ​The difference between call and put options
  • Individual stock options, stock index options, interest rate options and currency options
  • How options can be used for speculative and hedging purposes
  • Differences between using futures and options for hedging and speculative purposes
  • Different option strategies such as straddles and strangles
  • Different types of exotic option

Further Reading

Chisholm, A. (2004) Derivatives Demystified: A Step by Step Guide to Forwards, Futures and Options, Wiley.

Hull, J.C. (2008) Options, Futures and Other Derivatives, Prentice-Hall.

Kolb, R.W. and Overdahl, J. (2007) Futures, Options and Swaps, 5th edn, Basil Blackwell.

Multiple Choice Questions

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