Background
The exercise price, also called the strike price, is a critical element in the trading and valuation of options. An option is a financial derivative that gives the holder the right, but not the obligation, to buy or sell an asset at a predetermined price before or at expiration.
Historical Context
Options have existed for many centuries in various forms, but modern options trading became formalized with the founding of the Chicago Board Options Exchange (CBOE) in 1973. Exercise price has since become a standard term in financial markets, integral in options contracts for equities, commodities, and currencies.
Definitions and Concepts
The exercise price is the price at which an option holder can buy (call option) or sell (put option) the underlying asset.
Key Points:
- Call Option: Used to buy assets at the exercise price.
- Put Option: Used to sell assets at the exercise price.
- The option is exercised only if the exercise price is favorable compared to the market price.
Major Analytical Frameworks
Classical Economics
In classical economics, options and their pricing mechanisms are generally supported as tools for market efficiency.
Neoclassical Economics
Neoclassical economists focus on the efficient markets hypothesis (EMH), where the exercise price plays a role in derivative pricing models, like the Black-Scholes option pricing model.
Keynesian Economic
Under Keynesian economics, options can be viewed as instruments that can either stabilize or destabilize financial markets.
Marxian Economics
Marxist analysis might critique options trading, including exercise prices, as part of speculative activities in capitalist financial markets.
Institutional Economics
Institutional economists study the regulatory and operational frameworks that impact the practice and pricing of options in financial markets.
Behavioral Economics
Behavioral economists study how cognitive biases and emotions affect the decisions made by investors when options are in or out of the money relative to the exercise price.
Post-Keynesian Economics
This framework may examine options as financial vehicles impacting liquidity and investment behaviors.
Austrian Economics
Austrian economists might scrutinize the role of options and their exercise prices through lenses servicing their priorities of free markets and individual choice.
Development Economics
In developing economies, how exercise prices influence market participation and risk management within underdeveloped financial markets might be explored.
Monetarism
Monetarists may evaluate the effects of options trading, including exercise price mechanisms, on money supply and inflation.
Comparative Analysis
Comparing how the concept of exercise price is treated across different financial markets (equities vs. commodities vs. currencies) will highlight variations in valuation practices and market behaviors.
Case Studies
- Case Study 1: The role of exercise prices leading to the financial crisis of 2008.
- Case Study 2: Exercise prices during the 2020 COVID-19 market volatility.
Suggested Books for Further Studies
- “Options, Futures, and Other Derivatives” by John C. Hull
- “Understanding Options” by Michael Sincere
- “The Intelligent Investor” by Benjamin Graham
Related Terms with Definitions
- Call Option: A financial contract giving the buyer the right, but not the obligation, to buy an asset at a specific price within a particular period.
- Put Option: A financial contract giving the buyer the right, but not the obligation, to sell an asset at a specific price within a particular period.
- In the Money (ITM): A term describing an option with an exercise price that is favorable compared to the market price.
- Out of the Money (OTM): A term describing an option with an exercise price that is not favorable compared to the market price.
- At the Money (ATM): An option with an exercise price that is equal to the market price of the underlying asset.
Completing these sections gives thorough insights into the role, impact, and analytical frameworks surrounding the exercise price in resourceful ways for anyone new to economic and financial terms.
