Understanding Options

An option is a contract agreed upon by both parties, where the underlying asset is "the right." At the time of the transaction, the buyer (Buyer) pays a certain amount (the premium) to obtain the right specified in the contract (but not the obligation); while the seller (Seller or Writer) receives the premium but is obligated to fulfill the contract if the buyer chooses to exercise the right. The right acquired by the option buyer allows them to buy or sell a specific underlying asset (Underlying) at an agreed price (Strike Price or Exercise Price) in the future, within the stipulated expiration date (Expiration Date), quantity, and specifications.
Options can be divided into call options and put options based on the rights acquired by the buyer:
Call Option: The buyer of a call option has the right to buy the underlying asset at the agreed strike price, quantity, and specifications on or before the expiration date. The seller of the call option is obligated to sell the underlying asset as per the agreement.
Put Option: The buyer of a put option has the right to sell the underlying asset at the agreed strike price, quantity, and specifications on or before the expiration date. The seller of the put option is obligated to buy the underlying asset as per the agreement.
Furthermore, based on the exercise period, options are classified as either European options or American options:European Option: The buyer can only exercise the option on the expiration date.American Option: The buyer can exercise the option on or before the expiration date.

For the buyer, an option is a right rather than an obligation. To obtain this right, the buyer must pay a price, the premium. Conversely, the seller provides the right and assumes the obligation to fulfill it, so they receive the premium. The price of the premium, like in other markets, is determined by supply and demand, based on what the buyer is willing to pay and what the seller is willing to accept. When both parties agree on a price, the transaction is completed.

The price of the premium is determined by market supply and demand. When the buyer and seller negotiate the premium price, factors such as the spot price, strike price, duration, volatility, interest rates, and cash dividends affect the price. The table below shows the impact of various factors (with other factors held constant) on the value of call and put options:

The value of the premium includes intrinsic value (also called exercise value) and time value. Intrinsic value refers to the profit that can be realized by exercising the option before it expires, while time value is the portion of the premium that exceeds the intrinsic value.

The exercise price (also known as the strike price) of an option is determined by the exchange based on specific principles, while the exercise price of a warrant is set by the issuer and remains fixed during the contract's term. On the other hand, the settlement price of a futures contract is determined by market supply and demand, and can fluctuate with market conditions. In both the options and warrant markets, the premium is determined by the buyer and seller, not the settlement price of the underlying asset.
Both options and futures have no issuer, and there is no limit on their market circulation; as long as there is a buyer and a seller, positions can be created. In contrast, warrants must be issued by institutions that meet certain criteria, and their issuance is limited in quantity, meaning they cannot be issued without restriction.
The expiration months for options and futures contracts are determined by the exchange. Generally, the expiration months consist of two or three near months, along with a few quarterly months, and the maximum duration is typically within one year (some exchanges also offer long-term options with expirations beyond one year). The term of a warrant is determined by the issuing broker, and its duration is usually longer than one year.
The buyer of both options and warrants holds the right to choose whether to exercise the contract. In an option, the seller is obligated to fulfill the terms of the contract, while in a warrant, the issuer assumes the obligation to perform the delivery as required by the buyer. In contrast, once a futures position is established, both the buyer and seller are obligated to fulfill the terms of the contract until it is offset.
Once a warrant is issued, it can only be transferred as a right in the secondary market, with the issuer still holding the obligation. In the options market, anyone who establishes a seller position must assume the obligation to fulfill the terms of the contract.
The option and warrant contracts grant the buyer rights, which come at a cost. The buyer must pay the seller a premium, which represents the value of the option or warrant contract. Additionally, since the seller of an option has an obligation to fulfill the contract, the seller must deposit a margin as a guarantee of performance. In contrast, the obligations for a warrant are borne by the issuer, who must meet certain conditions and hold a sufficient quantity of the underlying asset to ensure performance. However, the issuer does not need to deposit margin. In futures contracts, there is no transfer of money at the time of the transaction; the margin deposited serves as a guarantee for performance, and both the buyer and seller are required to deposit it.
When options are listed, they feature not only different expiration months but also various strike prices. If the price of the underlying asset fluctuates significantly during the contract's term, new strike prices may be added. Combined with the differentiation between call and put options, this results in a large number of contracts being simultaneously listed. Warrants also have different expiration dates and strike prices, but these are fixed at issuance and do not increase in response to changes in the price of the underlying asset. Typically, each warrant issuance has only one expiration date and one strike price (a single series), making it similar to an individual stock, so the number of contracts for the same underlying asset is limited. For futures, only expiration months vary when they are listed, leading to a relatively limited number of contracts.
Since option sellers and both buyers and sellers in futures contracts have fulfillment obligations, they are required to post margin as a performance guarantee. This margin amount is generally limited to cover the maximum one-day loss, making it relatively low. Therefore, daily settlements are conducted, and if the margin falls below a certain level, additional funds must be posted. The obligations for warrants, however, rest with the issuing broker, who must hold a certain amount of the underlying asset to issue them; thus, no margin is posted, and daily settlements are unnecessary. For buyers of options and warrants, once they pay the premium, they bear no further obligations or risk and do not need daily settlements.

For product information, please refer to the Taiwan Futures Exchange website.Product information