Options are financial instruments that allow individuals to profit significantly from market fluctuations on an underlying asset, which can be a security, a stock, a share or even a commodity. When the investor trades an option, the option has a value that is based upon two factors; time and intrinsic value. Options are issued for a limited time frame and have an expiration date. The further out the expiration date the higher value the option has, following normal trading policies and regulatory guidelines.
Intrinsic value for an option is typically is based upon the difference between the current value of the underlying security that an option is based on and the strike price. A strike price is the price when the investor can sell or purchase the underlying asset or security depending on the type of option, before the exercise date. Call options are options where the option holder or the potential investor is betting that the underlying asset and / or security will increase in value before the expiration date; while put option holders are betting that the underlying security will decrease in value before the expiration date. The flow of information is often conceived to be in opposite directions for these two option holders. If you own an call option that is closer to the strike price than it will have a higher intrinsic value than an option that is further from the strike price. Interesting, isn’t it? This is indeed what is driving the highest focus for all the MBA and Business graduates focussing on a career in finance, starting from investment banking to derivatives trading.
Many financial traders purchase options as opposed to selling them, for a time space continuum. When you write an option you are betting that the option contract will expire without being in the money, and thus create some additional benefit from the information exchange and asymmetry. When an individual writes an option they receive an upfront premium payment for the option. This individual premium represents the maximum that they can earn on the trade of the specific option. The risk by selling a naked option contract is unlimited though. One option trader dubbed selling naked option contracts as equivalent to picking up pennies on the highway. While there is a significant amount of risk in writing options, much of this risk can be hedged by purchasing an option contract at a further price from the current value of the underlying security as protection. If you lose on the option writing contract you will be protected from unlimited loss through the option contract you are purchasing as protection.
If your business is doing well and you don’t need any help. Things are flowing right along and there’s no end in sight to what you can do. So, why would you need a cash advance to help your business? However, when things are not going right, Options can help you to mitigate the risk of getting all out in the dry times. At the moment, you may not need it. But think ahead a little and put that extra resource into some planning for the future.
Collin is a regular blogger on financial topics in management. He sits on the advisory board for multiple renowned ventures and has funded many venture capital enterprises. He loves blogging and enjoys the occasional trips to exotic locations across the globe.