Option
The option buyer pays a premium for the right to buy under a call or sell under a put. The writer has the corresponding obligation if exercise occurs. A European-style option can be exercised at expiry; an American-style option can be exercised within its permitted period. These labels describe exercise rights rather than geography. The buyer can let an unfavourable option lapse, but loses the premium paid. Payoff from exercise differs from profit after the premium and other costs. Options can protect against adverse movements while preserving some favourable outcomes.
Worked example
A company buys a right to purchase an input at $10. If the market price is $13 at exercise, the right can protect against the increase. If market price is $8, it can buy at market and let the right lapse, but the premium is still a cost.
Common mistake
Saying an unused option costs nothing, or describing the option writer as having the same freedom to walk away as the buyer.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Supporting | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |