What are Exchange Traded Options?

Charity Delich

Exchange traded options are contracts that give the right, but not the obligation, to purchase or sell financial products. These types of options are also called “ETOs” or “listed options.” Most ETO contracts include a set price for the product, which is commonly referred to as the strike price. Exchange traded option contracts also typically specify the underlying asset, quantity and expiration date. While the right to buy or sell the product can generally be exercised on or before the expiration date, the option becomes void after the expiration date.

Sophisticated traders often use exchange traded options to speculate on potential trades.
Sophisticated traders often use exchange traded options to speculate on potential trades.

Exchange traded options can either be call options or put options. A call option provides the ability to buy the underlying asset, and a put option secures the right to sell the underlying asset. If an investor believes a stock price is going to increase, he or she may retain a call option in order to benefit from the stock's rise. On the other hand, if a stock owner believes a stock price is going to drop in the future, he or she may try to secure a put option.

While many types of ETOs exist, exchange traded stock options are one of the most common forms. Stock options work the same as other ETOs, allowing investors to buy or sell stock at the strike price on or before the expiration date. Other frequently traded ETOs may include exchange traded currency options, commodity options and exchange-traded futures and options.

Investors can realize a number of advantages by using exchange traded options. One key benefit can be the ability to lock in a buying or selling price. This allows buyers and sellers to hedge against potential falls or rises in prices. Exchange traded options are generally considered liquid investments because they can be bought and sold relatively easily. This may be an added benefit for buyers and sellers that wish to maintain the liquidity of their assets.

Sophisticated traders often use exchange traded options to speculate on potential trades. Traders may profit from their views about the future direction of an option by locking in prices in advance. For example, buyers may seek to purchase exchange traded stock options for less than their current prices. Depending on how the market shifts, this could lead to significant profits. Exchange traded option can also provide the ability to generate income through using strategies like short-selling or writing options against existing shares.

ETO contracts can be traded on regulated exchanges, and their terms are generally dictated by the standards that apply to such exchanges. Typically, exchange traded options are traded through full-service brokers, discount brokers or advisors that provide trade execution services. Before making investment decisions, an investor with limited time or trading experience may need additional advice on the market risks associated with specific options.

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