Different Types of Options

There are a number of different types of options, including exchange-traded, over-the-counter and employee stock options.

Exchange-traded options

Exchange-traded options are listed on exchanges. They have standardised contracts defined by the exchange, and this standardisation can make accurate pricing models available to investors. The exchange acts as an intermediary to all transactions, so exchange-traded options are settled through a clearing house.

Different types of exchange-traded options include stock, commodity, stock indices, bond and interest rate, and futures options.

Over-the-counter

Over the counter (OTC) options are not listed on an exchange, but are traded between two private parties. As there is no standardisation, the terms of an OTC option can be individually tailored to meet business needs and are usually privately negotiated. Reporting OTC trading amounts can be difficult, due to the trades not being visible on an exchange.

In general, one of the counterparties of an OTC option is a well-capitalised institution. Different types of OTC options include interest rate, forex and swap options.

Employee stock options

An employee stock option is a call option on the stock of that employee’s company, giving the employee the right but not the obligation to buy a certain amount of stock. These options are generally issued by management to the employee as part of an employee’s salary or bonus. Employee-type stock options may also be offered to non-employees, such as lawyers, consultants, promoters and suppliers.

Employee stock options are non-standardised and are issued in a private contract between employers and employees. This makes them different to those traded on exchanges, which have a standardised exercise price and a standardised amount (100 shares per contract in the US, and 1,000 in Australia). Their expiration date also exceeds the maturity of standardised options, with some employee stock options having a maximum maturity of ten years from the issue date.

Employee stock options may also be on a vesting schedule – meaning that the number of shares available to be exercised at the strike price will increase as time passes.

Restrictions, such as limited transferability, can be used to align the option holder’s interest with those of the company’s shareholders. If the company’s stock rises, holders usually experience a financial benefit, giving employees an incentive to boost the company’s stock price through their work and behaviour.

Other types

Many financial contracts use other types of options, such as real estate options, which are used to bring large parcels of land together, and prepayment options are usually included in mortgage agreements.

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