there are certain types of derivatives that can require an additional
outlay of capital over and above the original investment. The obligation to make
such margin payments can amount to many times the purchase price of the investment.
Unlimited risk is particularly associated with:
As the buyer of an option, you have the right to buy a specified amount of an underlying
asset (often simply referred to as the “underlying”) from the seller (call
option) or sell it to the seller (put option) at a predefined price (strike price) up until
a set time (expiration date). The price you pay for this right is called the premium.
Where a call option provides for physical settlement, you can require the seller of
the option (writer) to deliver the underlying asset when you exercise the option. With
a put option, the writer is obliged to buy the underlying asset from you.
Generally speaking, if the market value of the underlying asset falls, so does the value of
your call option. The value of your put option tends to fall if the underlying asset rises
in value. Normally, the less your option is in the money, the larger the fall in the option’s
value. In such cases, value reduction normally accelerates close to the expiration date.
With a covered option, you purchase an underlying asset (equity, bond or currency)
and simultaneously write a call option on that same asset. In return, you are paid a
premium, which limits your loss in the event of a fall in the market value of the
underlying asset. By the same token, however, your potential return from any
increase in the asset’s market value is limited to gains up to the option’s strike price.
Traditional covered options require that the underlying asset be lodged as collateral,
which makes you the covered writer.
With a lookback option, the market value of the underlying is recorded periodically
over a specified time period.
For a strike-lookback option the lowest value (call option) or the highest value (put
option) of the underlying becomes the strike price.
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