EUA Options - What are Options?

An EUA option is a contract whereby one party (the holder or buyer) has the right, but not the obligation, to exercise the contract (the option) on or before a future date (the exercise date or expiry). The other party (the writer or seller) has the obligation to honour the specified feature of the contract. Since the option gives the buyer a right and the seller an obligation, the buyer has received something of value. The amount the buyer pays the seller for the option is called the option premium.

A put option is the right to sell a futures contract, and a call option is the right to buy a futures contract. Because this is a commodity whose value is determined by an underlying instrument, it is classified as a derivative. In many cases, options are traded on futures. This is also the case with ICE ECX EUA Options, which are based on ICE ECX EUA Futures. For both, the option strike price is the specified futures price at which the future is traded if the option is exercised.

An options contract differs from a futures contract where the holder gives the right and the obligation to buy or sell. In other words, the owner of an options contract can exercise (to buy or sell) on or prior to the pre-determined settlement/expiration date. Both parties of a futures contract must exercise the contract (buy or sell) on the settlement date. ICE ECX EUA Options contracts ensure the possibility of delivery of European Union Allowances (EUAs).

Standardisation

• The underlying commodity (in this case EUAs)
• Whether it is a put option or call option.
• The strike price or exercise price. It can be specified, or based on a reference rate, or measured at agreed-upon intervals during the life of the contract.
• The date that will be either the last possible date for exercise (American options), or the only date for exercise (European options). ECX options follow European-style exercise.
• The quantity of the commodity included in each contract. This is standard and predetermined by the exchanges for traded options.

Key points about Options

• The buyer pays the price (premium) to the seller (writer). He assumes a long position, and the writer a corresponding short position. Thus the writer of a call option, is "short a call" and has the obligation to sell to the holder, who is "long of a call option" and who has the right to buy. The writer of a put option is "on the short side of the position", and has the obligation to buy from the taker of the put option, who is "long a put". See the basic option trades below.
• The option style determines when the buyer may exercise the option. It will affect the valuation. Generally the contract will either be American style - which allows exercise up to the expiry date - or European style - where exercise is only allowed on the expiry date. European contracts are easier to value. ECX options follow European Style.
• Buyers and sellers of exchange-traded options do not interact directly - the exchange acts as intermediary. The seller guarantees the exchange that he can fulfil his obligation if the buyer chooses to execute.
• The risk for the option holder is limited: he cannot lose more than the premium paid as he can "abandon the option". His potential gain with a call option is theoretically unlimited; see strike price.
• The maximum loss for the writer of a put option is equal to the strike price. In general, the risk for the writer of a call option is unlimited. However, an option writer who owns the underlying instrument has created a covered position; he can always meet his obligations by using the actual underlying. Where the seller does not own the underlying on which he has written the option, he is called a "naked writer", and has created a "naked position".
• Options are said to be at-the-money if the underlying value currently equals the strike price, the option is said to be in-the-money if it has positive intrinsic value, or out-of-the-money if it has zero intrinsic value. Additional to the intrinsic value an option has a time value, which decreases the closer the option is to its expiry date.