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Options give the buyer the right but not the obligation to buy or sell an asset (underlying) on a future date at a pre-set price (strike price). A fee (premium) is generally paid upfront for this flexibility. There are two types of options:
Call: it grants the buyer the right to buy the underlying asset at a predetermined price. It can be exercised when the market prices are higher than the predetermined price.
Put: it grants the buyer the right to sell the underlying asset at a predetermined price. It can be exercised when the market prices are lower than the predetermined price.
The risk for the buyer is exclusively the premium paid.
Option contracts have an expiry date by which the owner has the right to buy the underlying asset (call) or sell it (put). Different categories of options can be identified depending on the expiry:
American options – The right to buy or sell can be exercised at any time prior to and including the expiry date.
European options – The right to buy (call) or sell (put) the underlying asset can be exercised only on the expiry date.
Asian options – Options in which the payoff is determined by the average price of the underlying in a specified period of time.
More specifically, in the case of Brent and other oil products, when an American option is exercised the buyer obtains (for calls) or sells (for puts) a future on the underlying at the agreed fixed price (strike).
If a European option is exercised instead, only the mark-to-market is exchanged at maturity.
Similarly, when Asian options are exercised only the mark-to-market is exchanged, but in this case the value of the final payoff depends on the average of the prices of the underlying during a given period.
The exposure of a physical position can be replicated in exchange for a premium.
Options that can be used in many ways to create customized positions and cover risks.
Risk reduction (for the buyer)
No exposure to adverse price movements: the premium constitutes the maximum loss.
The graph shows the value at expiration of option contracts. This value (y axis) is obtained through the possible exercise of the option. For example, in the case of the purchase of a call, the value of the contract at expiration will be higher when the difference between the value of the unerlying and the strike is bigger. If at expiration the value of the underlying is lower than the strike, the value of the contract will be zero because the option is not excercised.