Explainer

The Options Basics Explainer introduced the concepts of call and put options, strike price, expiry, and long or short positions in an option contract. This page looks in more detail at option pricing.

Besides buying or selling single options, there are many other possible strategies that involve positions in multiple options simultaneously, as well as combining options with positions in the underlying assets. While there are infinite combinations possible, we start with two common combinations below.

What are options? An option is a type of derivative contract that gives the holder the right to buy or sell the underlying asset at a predetermined price – the exercise or strike price – at or before a certain date. Options exist on a wide variety of underlying assets, like single stocks, indices, ETFs, bonds, currencies, commodities. These contracts can serve as tools to protect a portfolio against potential losses or to express an opinion about the direction of the market.

Besides buying or selling single options, there are many other possible strategies that involve positions in multiple options simultaneously, as well as combining options with positions in the underlying assets.

Option combination strategies. Besides buying or selling single options, there are many other possible strategies that involve positions in multiple options simultaneously, as well as combining options with positions in the underlying assets. While there are infinite combinations possible, we outline one common combination below.

What do long/short positions in call options mean? In the simplest terms, there are four positions an investor can take in options: buying call options (long call), selling/writing call options (short call), buying put options (long put), and selling/writing put options (short put).

What do long/short positions in put options mean? In the simplest terms, there are four positions an investor can take in options: buying call options (long call), selling/writing call options (short call), buying put options (long put), and selling/writing put options (short put).

The Option Greeks are a collection of variables that measure the sensitivity of option prices to changes in underlying factors. Mathematically, they are derivatives of components of option pricing models. Each factor has a Greek letter assigned to it, hence the name ‘Greeks’.

Volatility is an important concept in the context of option trading, but it’s also one of the more complex ones to understand. In financial markets, volatility captures the amount of fluctuation in asset prices and is generally calculated as the annualized standard deviation of daily price changes, normally expressed as a percentage. To convert the annual level of volatility to the daily volatility, the annualized number is divided by the square root of 252 (~16), as there are 252 trading days in a year. An annualized volatility of 16% therefore translates to a daily volatility of 1%, meaning that on a daily basis the price moves on average 1%. It should also be noted that volatility only says something about the degree of price fluctuation, not whether the change is up or down.

If you wish to understand the real size of options markets, don’t stop at contract counts.

For a trade to happen, there needs to be an order first. Investors send orders to the exchange that transmit instructions to buy or sell. Buy 50 shares of Apple stock. Sell 20 shares of the SPDR S&P 500 ETF. While orders may or may not ever become actual trades, they’re the building blocks of some of trading’s most important concepts. In this explainer, we’ll break down the different types of orders and what they represent.

Much of the attention paid by the public to financial markets is typically directed at pre-trade – when orders go into an order book to be filled – or trading itself. Occasionally however attention shifts to post-trade, or what happens after a trade has been agreed. Now is one of those times, with the US’s move to T+1 settlement slated for next year.

Electronic trading is the buying and selling of financial instruments through automated systems on exchanges worldwide. Market makers like Optiver continuously post two-way prices across millions of instruments, allowing investors to buy and sell quickly at fair prices.

Wholesale and institutional trading refers to large-scale transactions between financial firms, negotiated away from the public order book. Market makers like Optiver provide liquidity on request, absorbing large orders in a single trade.

An RFQ is a trading protocol where an institution asks one or more market makers to submit a price for a specific transaction. It is widely used in ETF and options markets alongside continuous electronic quoting.

Floor trading is a method of executing trades on a physical exchange floor through verbal and hand signal communication. Optiver maintains a floor presence at the Cboe Options Exchange in Chicago, trading S&P 500 index options.

A direct counterparty (DCP) is an institutional investor that trades directly with a market maker without an exchange or broker as intermediary. DCPs include pension funds, asset managers, and other large institutions that need to execute in size.

Hedging is the practice of taking an offsetting position to reduce the risk of adverse price movements in an existing position. It is used by investors, corporates, and market makers to manage exposure to market risk.