Options

An option is a contract giving the right to sell or buy a commodity, financial instrument or index, at a specified price for a certain period. In other words, like futures, options are derivatives which allow you to put down a small stake and give yourself exposure to a much larger investment. Like futures, they can be used to minimise or maximise risk.

There is one key difference between options and futures. If you buy a futures contract, you have agreed to take delivery of a commodity (say 10 kilos of sugar) at a given date in the future. You have no alternative (unless of course you sell the contract on to somebody else).

With an option, you are not bound to take delivery. If you choose, you may decide against taking delivery and let the option 'lapse'.

Options can be (and are) extended beyond the commodity markets. Companies have often in the past given their top managers 'executive share options'. These enable the managers to purchase shares in the business in the future at a price fixed now. Options in this context are used as an incentive to provoke the managers into performing better.

Options contracts have intrinsic value. This has led them to be bought and sold on exchanges such as the London International Financial Futures Exchange (LIFFE).

Last Updated: February 2008 © Moneyextra.com

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