Puts
A put option is an option that guarantees the holder a right to sell an underlying asset at a strike price. The writer of a put option is legalized to buy the bond at the strike price. A put option is exercised before the stock expires at any time ( Singh, 2010) . Investors purchase put when they think that the share price of the underlying asset will go down or sell it when they think it will rise. Example of a put option is illustrated below.
Put options Expires at close Friday, January 18, 2013
Strike Symbol last Chg Bid Ask Vol Open Int
400.00 AAPL130119P00400000 64.50 2.80 64.65 65.60 34 1,951
405.00 AAPL130119P00405000 58.40 0.00 67.25 68.15 1 306
410.00 AAPL130119P00410000 69.95 2.86 69.80 70.85 4 582
415.00 AAPL130119P00415000 77.25 0.00 72.50 73.85 57 809
420.00 AAPL130119P00420000 67.32 0.00 75.20 76.30 36 648
Calls
It is an option that gives the holder the freedom to buy an underlying security at a specified price for a specific duration ( Singh & Basurto, 2008) . In case the bond fails to meet the strike price before the expiration date, call option expires and becomes worthless. Investors only buy calls when they think that the share prices of the underlying stock will rise and sell it when they think it will fall. Selling an option can also be referred to as ‘writing’ an option
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Straddles
A straddle is an options strategy whereby an investor occupies a position in both a put and a call with an equal strike price, expiration date and paying both premium charges ( Wang et al., 2005) . Straddle strategy assists investors to make a profit despite whether the price of the security falls or rises with an assumption that the stock price changes fluctuates somewhat significantly.
Collars
The collar is a protective strategy option which is being implemented following the long position in an asset has experienced substantial gains. A collar position can be created by an investor through the purchasing a put option and while he spontaneously sells a call option. Another term to refer to a collar is a hedge wrapper ( Singh, 2010) . The collar can also outline a general restriction on market activities, for instance, a circuit breaker that is meant to prevent extreme losses or gains in case an index reaches a certain level. However, a collar is usually used in options trading to describe the position of short call options, long put options and finally long shares of the underlying stock.
Swaps
A swap is a derivative contract whereby two parties exchange financial instruments like cash flows based on national principle amount agreed upon by those two parties ( Singh, 2010) .. Basically, swap principle does not change hands but instead, each cash flow does contain one leg of the swap. One cash flow is a variable while the other is fixed based on the benchmark interest rate index price. The most common type of swap used is an interest rate swap. Retail investors do not engage in swaps and it does not trade on exchanges.
Futures
Futures are contracts that derive value from an underlying asset. Future contracts are standardized contracts traded on a centralized exchange. A future contract is an agreement between two parties to sell or buy something at a future date at a certain price which is the price of the underlying asset ( Wang et al., 2005) . One party who agrees to buy is referred to as long while one who agrees to sell is termed as short. The parties involved in future contracts do not need to exchange a physical asset but instead the future price of that asset price at maturity. Futures are mainly used to manage different kinds of risks like foreign exchange risks.
Covered call
In this strategy, an investor holds a long position asset and sells a call option on the same asset with an attempt to generate increased income from the asset ( Singh & Basurto, 2008) . The buy-write strategy is often practiced when an investor has a short-term neutral view on an asset and therefore will hold the asset long and spontaneously has a short position through the option to generate income from the option premiums.
References
Singh, M. (2010). Collateral, netting and systemic risk in the OTC derivatives market.
Singh, M. M., & Basurto, M. A. S. (2008). Counterparty risk in the over-the-counter derivatives market (No. 8-258). International Monetary Fund.
Wang, L., Alam, P., & Makar, S. (2005). The value-relevance of derivative disclosures by commercial banks: A comprehensive study of information content under SFAS Nos. 119 and 133. Review of Quantitative Finance and Accounting , 25 (4), 413-427.
