Options

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options
45943 is a derivative Iinancial instrument that speciIies a contract between two parties Ior a
Iuture transaction on an asset at a reIerence price.

The buyer oI the option gains the right, but not the obligation, to engage in that transaction, while
the seller incurs the corresponding obligation to IulIill the transaction.
The price oI an option derives Irom the diIIerence between the reIerence price and the value oI
the underlying asset (commonly a stock, a bond, a currency or a Iutures contract) plus a premium
based on the time remaining until the expiration oI the option. Other types oI options exist, and
options can in principle be created Ior any type oI valuable asset.
An option which conveys the right to buy something at a speciIic price is called a ., an option
which conveys the right to sell something at a speciIic price is called a 5:9. The reIerence price
at which the underlying asset may be traded is called the strike price or exercise price. The
process oI activating an option and thereby trading the underlying at the agreed-upon price is
reIerred to as exercising it. Most options have an expiration date. II the option is not exercised by
the expiration date, it becomes void and worthless.
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In return Ior assuming the obligation, called writing the option, the originator oI the option
collects a payment, the premium, Irom the buyer. The writer oI an option must make good on
delivering (or receiving) the underlying asset or its cash equivalent, iI the option is exercised.
An option can usually be sold by its original buyer to another party. Many options are created in
standardized Iorm and traded on an anonymous options exchange among the general public,
while other over-the-counter options are customized ad hoc to the desires oI the buyer, usually
by an investment bank.
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Hedging is the process oI managing the risk oI price changes in physical material by oIIsetting
that risk in the Iutures market. Hedging can vary in complexity Irom a relatively simple activity,
through to a highly complex strategies, including the use oI options.

The ability to hedge means that industry can decide on the amount oI risk it is prepared to accept.
It may wish to eliminate the risk entirely and can generally do so quickly and easily using the
LME.

Managing price risk means achieving greater control oI either the cost oI inputs, or revenues
Irom sales, or both planning Ior the Iuture based on assured costs and revenues and eliminating
concerns that a sharply adverse move in the price oI material could turn an otherwise Ilourishing
and eIIicient business into a loss maker.

Hedging by trade and industry is the opposite oI speculation and is undertaken in order to
eliminate an existing physical price risk, by taking a compensating position in the Iutures market.
Speculators come to the Iutures market with no initial risk. They assume risk by taking Iutures
positions.

Hedgers reduce or eliminate the chance oI Iurther losses or proIits, while the speculators risk
losses in order to make proIits.

BeIore starting a hedging programme it is essential to assess the risk due to exposure to the price
oI physical material. Once the hedger has an understanding oI the tools available at the LME, it
is relatively easy to select the appropriate action to manage this risk. It is important that this
action is properly managed at all times and that the appropriate controls and approval procedures
are in place.

What Does lutures Mean?
A Iinancial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such
as a physical commodity or a Iinancial instrument, at a predetermined Iuture date and price.
Futures contracts detail the quality and quantity oI the underlying asset they are standardized to
Iacilitate trading on a Iutures exchange. Some Iutures contracts may call Ior physical delivery oI
the asset, while others are settled in cash. The Iutures markets are characterized by the ability to
use very high leverage relative to stock markets.

Futures can be used either to hedge or to speculate on the price movement oI the underlying
asset. For example, a producer oI corn could use Iutures to lock in a certain price and reduce risk
(hedge). On the other hand, anybody could speculate on the price movement oI corn by going
long or short using Iutures.

What Does urrency 5wop Mean?
A swap LhaL lnvolves Lhe exchange of prlnclpal and lnLeresL ln one currency for Lhe same ln anoLher
currencyŦ lL ls consldered Lo be a forelgn exchange LransacLlon and ls noL requlred by law Lo be shown
on a companyƌs balance sheeLŦ



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