The Stock Options - Research Paper Example

The Stock OptionsIntroductionHolding of stock represents ownership of a company. With regard to the context, it can be stated that each of the share of stock represents holding of ownership towards the company (Pankow, 2005). Stock and share are interrelated to each other. All stock option contracts are generally for 100 shares with regard to underlying stocks (Chicago Board Options Exchange, n.d.). The objective of this paper is to describe the various stock options along with its types, functioning and risk.

What Are Stock Options?The stock options can be defined as a contract made between the company and option holder which give rights but not the responsibility to deal the particular assets on a specified time at a fixed price (Sincere, 2006). There are two kinds of option namely ‘call option’ and ‘put option’, which are also termed as buy option and sell option respectively. Comparison among Put Stock Options, Call Stock Options and Employee Stock OptionsPut options can be defined as the right given to the buyer to sell certain number of stocks within a specified time to the option writer at definite price.

Whereas, call options can be defined as the right given to the investors to buy stocks from the option writer at specified price within the specified time. While, employee stock options can be defined as the right given to the company’s directors, employees, and officers to buy or sell stock at future date with a pre-decided price (The Newspaper for IT Leaders, 1999). Call options provides an advantage that it bears low risk for the investor as well as it is flexible in nature because it can be sold and bought within the specified time.

While, put options’ have certain advantages that include capability to lower the risk of decrease in price, facilitate to obtain credit, possess no deposit margin and purchasers are available (Extension Agricultural Economics, n. d.). Employee stock options advantages comprise value of the option increases with a rise in the fair value related to the stock along with a risk-free rate (Casson, 2007). How The Stock Options Work?The procedures of operating call options are the name of the company should be known and the company should have goodwill, the minimum number of share that the investor has to buy in order to regulate the options and also the options should be bought at the price fixed by the company’s options writer.

Whereas the procedures of operating put option include certain aspects that need to be known such as the name of the company whose share is to be sold, fixed number of shares to be sold, the striking or the selling price and the date of expiration of the option (Pandian, 2009). The employee stock options provide certain features such as these options cannot be transferred or sold by an employee, they are generally of longer duration i.e. around 10 years, they have certain vesting limitations that require a staff to wait for a specific period before exercising any particular option.

As a result, the employee has to serve the company for longer period of time to prevent the forfeiture of the option value (Baril, Betancourt, & Briggs, 2007). How Does Each Of These Types Of Stock Options Vary In Risk?There are certain risks present in each of the stock options. In case of put options, it requires premium payment, the options’ net price is not fixed and it is tough to estimate the price because of the present and the future stock price variation. In order to deal with the put options an investor has to pay an amount as brokerage to the middle party.

The put options generally deal with a fixed number of stocks (Anderson, Smith, McCorkle, & O’Brien, n.d.). Employee stock options’ possess a few risks for the employees as it is not transferable, employees cannot exercise or sell the option handed by the company, the value of options cannot be estimated during its tenure and the rate of return is not constant over the tenure (Adamson & Peterson, 2004). Whereas, the risks involved in the call options are the price of call option can vary with the influence of the underlying assets, the price of the option can fall with the rise of striking price, at the time of price instability of the underlying assets call stock options’ value can fall and the dividend return for the call option varies with the ex-dividend period variation (Pandian, 2009).

ConclusionTherefore, it can be concluded that stock options are the contracts made in between the company and the investor for the rights towards the company’s regulation. With these options, along with having an option of holding a company’s shares, investors enjoy more rights towards the company’s regulation. There are three types of stock options with which a company can deal with i.e. call options, put options and employee stock options. Proper assessment of these stock options is crucial in order to handle and deal with them in an appropriate way.

ReferencesAdamson, T., & Peterson, P. A. (2004). Employee stock options: An analysis of valuation methods. Retrieved from http://www.radford.com/home/ccg/valuation_services/article_aonresearch_nov2004.pdfAnderson, C., Smith, J., McCorkle, D. & O’Brien, D. (n.d.). Hedging with a put option. Retrieved from http://agmarketing.extension.psu.edu/Commodity/PDFs/HdgPutOption.pdfBaril, C., Betancourt, L., & Briggs, J. (2007).Valuing employee stock options under SFAS 123R using the Black–Scholes–Merton and lattice model approaches.

Retrieved from http://rricketts.ba.ttu.edu/Valuing%20Stock%20Options%20under%20FAS%20123R.pdfCasson, P. (2007). Employee stock options. Retrieved from http://www.qfinance.com/contentFiles/QF02/g1xtn5q6/12/2/employee-stock-options.pdfChicago Board Options Exchange. (n.d.). Understanding stock options. Retrieved from http://www.cboe.com/learncenter/pdf/understanding.pdfExtension Agricultural Economics. (n.d.). Hedging with a put option. Retrieved from http://agecoext.tamu.edu/fileadmin/user_upload/Documents/Resources/Risk_Management/rm2-12oh.

pdfPankow, D. (2005). Understanding stock and the stock markets. Retrieved from http://www.ag.ndsu.edu/pubs/yf/fammgmt/fe605.pdf Pandian, P. (2009). Security analysis and portfolio management. India: Vikas Publication House Pvt. Ltd.Sincere, M. (2006). Understanding option. United States: The McGraw-Hill Companies.The Newspaper for IT Leaders. (1999). Computer World. Business quick study 33 (40), pp. 58.