Options are derivative contracts that give the holder the right, but not the obligation, to buy or sell the underlying instrument at a specified price on or before a specified future date. Although the holder (also called the buyer) of the option is not obligated to exercise the option, the option writer (known as the seller) has an obligation to buy or sell the underlying instrument if the option is exercised.
Depending on the strategy, option trading can provide a variety of benefits including the security of limited risk and the advantage of leverage. Options can protect or enhance an investor’s portfolio in rising, falling and neutral markets. Regardless of the reasons for trading options or the strategy employed, it is important to understand the factors that determine the value of an option. This tutorial will explore the factors that influence option pricing, as well as several popular option pricing models that are used to determine the theoretical value of options.