Monday, 28 September 2015

What Is Options Settlement In The First Place?

Settlement in options trading is the process where the terms of an options contract are resolved between the holder and the writer. In options trading, the holder is the one who owns an options contract and a writer is the person who sold the holder that options contract. Settlement  in call options contracts involve the holders of the options contracts paying the writers for the underlying asset at the strike price. Settlement in put options contracts involves the holder of the options contract selling the underlying asset to the writer at the strike price. After settlement, the options contract will cease to exist and all obligations between the holder and the writer would be resolved.

Settlement can happen under 2 circumstances; Voluntary exercise by the holder or automatic exercise upon expiration.
The holder of an American Style Option could choose to voluntarily exercise their options any time prior to expiration. Once that happens, settlement takes place between the holder and the writer and the options contract is resolved.


Upon expiration of an options contract, whether American Style or European Style, it is automatically exercised if it is in the money on expiration day. Once that happens, settlement takes place between the holder and the writer and the options contract is resolved.
Options Settlement Styles
There are two main ways in which options are settled in options trading; Physical Settlement and Cash Settlement.
Cash Settlement: Cash settlement involves only settling the profit/loss in cash between the holder and the writer without the transfer of any actual assets, just like settling a bet.
Physical Settlement: Physical settlement involves the transfer of the actual underlying asset between the holder and the writer as described above and is the most common type of settlement method. In fact, all stock options that are publicly traded in the US are Options Settlement where you actually get the stocks if you exercise a call options and actually get to sell your stocks if you exercise a put option. In fact, due to this characteristic, almost all physically settled options are American Style Options which you get to exercise at any time prior to expiration.

 

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