Future opportunities at a pre-set price.
The options give the buyer the right, but not the obligation, to buy or sell an underlying asset 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: gives 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: gives 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.
In the case of coal, or freights, we refer to swaptions (swap-options) because if the option is exercised the buyer will obtain (for calls) or sell (in the case of puts) a swap on the underlying at a fixed price (strike).
The expiry of the option for the coal takes place one month before the start of the reference period for the underlying. For example an option on Q318 expires on 01/06/2018.
For freights almost exclusively Asian options are traded, so the expiry date is the same as the one of the underlying swap. For example a freight option on Q318 will expire on 30/09/2018, as the swap does.
The risk for the buyer is exclusively the premium he paid.
Vanilla and Exotic Options
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:
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 predetermined period of time.
The exposure of a physical position can be replicated in exchange for a premium.
Options that can be used in multiple 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.