HOME >

Options Clearing


An option is a contract which gives you the right - but NOT the obligation - to either buy or sell the underlying asset within a specified time frame. Options can be very tricky to use and as a result they frighten many people.

But let us consider why one would use an option. If you purchase a buy option contract, also known as a "call", it means that you and a seller of a commodity agree upon a price today that you will pay for the right to buy that asset unless you first sell the contract or simply let it expire. You can exercise your option at any time during the agreed upon time frame, and if you do so the seller MUST sell you the asset for the money you told him you would pay (known as the “strike price”) on the date of the contract's creation. Now, let's imagine that you use an options buy contract or call on a house purchase. The owner of the house agrees, for an initial non-refundable deposit, that you will buy the house for an extra £300,000 within four months unless you've sold the contract or allowed the contract to expire without "exercising your option". Options contracts are all bought with non-refundable up front premiums, which are very small compared to the contract's value. So, let's say the seller of the house agrees to sell you the house at any moment for £300,000 in the next four months if you give him £10,000 today. You pay him the premium and you enter into the contract. Your objective is to secure the house against other buyers while you come up with the rest of the cash you need to buy it.

Now, guess what? It turns out that John Lennon is still alive, and living in...that house! This becomes public knowledge and the value of the house leaps to over £3,000,000. You call the seller and exercise your option--he MUST sell you the £3,000,000 house at the agreed upon price of £300,000. You just made out like a bandit, realizing a profit of £2,690,000. This is what makes options trading so attractive.

On the other hand, what if you were the owner of the house and had agreed to purchase a "put" contract from the potential purchaser.  You would then have the right, but no obligation, to demand that he buys your house for an agreed upon price (the “strike price”), £300,000, at any time in the next four months. You pay him £10,000 for the put and that money is his to keep no matter what. Now, why did you buy that put contract? You really want to get rid of this house but you are nervous of the value of the house going down, down below the price you believe is fair value. It turns out that the house was built over a druids’ burial site and it's super-haunted. When this is discovered, the house's value plummets. You contact the potential purchaser, the person from whom you bought the put, and you “put” the house on him.  He must buy the house from you for £300,000 even though it is considered to be worth far less than that.  You sold the house for £300,000 less the £10,000 of premium but it has just been re-valued at £150,000 so it was a good trade.

Real, heavily traded options contracts underpinned by securities are traded through clearing houses, or clearing firms.  Charged with the duty of making certain that transactions run smoothly, clearing houses become buyers for every seller, and sellers for every buyer. So, they take the offsetting position with a client for every transaction. Options clearing firms enable options to be traded.

A good quality clearing house should generate real-time statements so that clients can access the internet to view a new contract and related underlying asset status within seconds of trading.  Also, since all clearing houses demand that money be deposited to facilitate any member's trade, one should look for a clearing firm that can provide a margin calculator that clients can use to accurately estimate margin calls as options are bought on margin.



<< back
EXECUTION

The Kyte Group Limited was founded by David Kyte in 1985 on LIFFE, the embryonic futures exchange in the heart of the City of London.
READ MORE

Kyte's customers are market professionals, either sole traders, teams of market,
READ MORE

Providing clearing and settlement services to professional traders who transact business on the world's leading exchanges.
READ MORE