An option is a derivative through which the buyer has the right – but not the obligation – to buy a specific underlying instrument at a predetermined price, either on or before a specific date in the future. They are divided into options to buy the underlying instrument (call option) and options to sell the underlying instrument (put option). The underlying instruments are stock market indices (index options) and shares (stock options). The use of options is for the purpose of hedging risk or speculation. Unlike futures, the buyer has the option, but not the obligation to buy or sell depending on the transaction, the underlying instrument in the future. The seller of the product, on the other hand, is always obliged to sell or buy the underlying instrument at the agreed price if the buyer exercises his right. The basic characteristic terms of options are the Exercise Price (Strike Price) of the contract at which the underlying product is bought/sold by the counterparties, the Expiration/Exercise Date, the Multiplier which defines the quantity of the underlying product and the Premium price of the option which is in fact the price received by the seller of the respective option.

Options are classified according to the time limitation of their exercise into American style options (American style option) where an investor can exercise it at any time between the purchase and expiration dates and European style options (European style option) where the investor can only exercise it at expiration. They are categorised into Index options with an underlying stock market index and Stock options with a listed share as the underlying instrument. In the Greek market, stock options are American-style.

It is worth mentioning that investments in derivative products have a high degree of risk as the position in the derivatives market is a multiple of the originally invested funds (leverage). More specifically, futures contracts involve a high degree of risk as the leverage that comes with them means that a small commitment of capital can lead to very large losses as well as very large gains. The investor should be aware of the obligations and consequences of trading in futures contracts. These relate primarily to the margin requirements of the margin account and the possibility that the investor may be required to pay additional initial funds in order to maintain his position. As far as options are concerned, the buyer’s exposure to risk is less than the seller’s, because if the price of the underlying security moves in the opposite direction to that anticipated by the buyer, the buyer has the option not to exercise the option. The greatest potential loss is not limited to the total price of the right. However, in the case of an investor who has a seller position in an option, the risk assumed is significantly greater than that of an investor who has a buyer position. This results from the obligation to buy or sell the underlying security in case the counterparty (buyer) proceeds to exercise the option and from the fact that during the whole period of holding the option the seller has to cover the margin account, which involves a liquidity risk. Thus any loss to the seller may be from high to unlimited.

The volatility of a particular market index expresses the magnitude and frequency of fluctuations in the price of the corresponding market index over a specific period of time. It is measured by calculating the annual standard deviation of the daily changes in the price of the security/reference index. The greater the volatility, the greater the risk of the security or the securities that make up the market index. In particular, volatility reflects the uncertainty about the magnitude of the change in the price of the security. The higher the volatility, the more likely it is that the price of the security will move within a wide price range. That is, the price of the security may move sharply within a short period of time in either direction (sharply decreasing or increasing). Conversely, lower volatility means that the price of the security usually does not fluctuate strongly and follows that of the benchmark. The beta of a security or, equivalently, a portfolio is an indication of its volatility in relation to market fluctuations. If the β of a security is greater than one (β=1.1), its price is 10% more volatile than the market as a whole. When β is less than unity (β=0.90) the price changes 10% less than the market. Thus, the higher the β, the higher the volatility of the security/product relative to market movement.

The main use of derivative products is to hedge the investment risks of a long position in the spot market. This means that when an investor has bought securities in the spot market expecting their price to rise in order to make a profit, through derivatives he can hedge the risk by opening short positions (selling) in derivative products that have as underlying instruments the securities he has bought in the spot market. Thus, in the event of a fall in the prices of securities on the spot market, the investor’s short positions in the derivatives market will bring him profits, which will offset part of his losses on the spot market. There is of course the possibility of speculation on the part of the investor by opening positions in derivative products in the derivatives market in one direction (bullish or bearish). If the investor believes that prices will move upwards he can buy call options by paying only the premium of the purchase price multiplied by the size of the contracts multiplied by the number of contracts. Otherwise, if he believes that prices will move downwards, he can buy put options by also paying only the premium multiplied by the size of the contracts multiplied by the number of contracts. In case the market moves against his expectations, his maximum loss is equal to the sum of the premiums he has paid to buy the rights. Similarly, if the investor believes that prices will move upwards, he can sell put options by receiving the premium multiplied by the size of the contracts multiplied by the number of contracts, and if he thinks that prices will move downwards he can sell call options by receiving the premium multiplied by the size of the contracts multiplied by the number of contracts. In this case, however, if the market moves in the opposite direction to expectations, the maximum potential loss is unlimited.

• • Derivatives short position risk: this is the risk that the investor assumes in the event that he has sold call options on underlying products that he does not own. If the market moves against the expectation of the investor-seller (the price of the underlying product in the spot market is higher than the exercise price of the option) the buyer of the option has the possibility to exercise this option, with the consequence that the seller is obliged to buy the product in the spot market, usually at a price much higher than the price (strike price) at which he is obliged to sell it to the buyer.
  • Margin Account Risk: This is the risk that an investor (who has a position in the derivatives market) assumes of losing the entire capital he/she has initially invested. If the market moves against the investor’s estimates, the immediate payment of additional funds for insurance will automatically be requested. There is therefore the possibility of losing additional funds beyond the initial ones. In the Greek market, an investor’s inability to cover his obligations with a margin call he has accepted causes the immediate liquidation of his portfolio by the Greek Stock Exchange authority, resulting in the complete loss of the amount deposited in his margin account. The determination of the lower limits of the insurance margin is made by the Greek Stock Exchange authority and is based on the historical volatility of the prices of the underlying products. However, AXON Securities may set higher limits as insurance margins in order to safeguard both the Company and the client.
  • Derivatives market divergence from the underlying securities market: the risk that the prices of derivative financial instruments will diverge from the corresponding prices of the underlying securities due to the conditions or operating rules of the derivatives market or the underlying securities market.
  • Investment practice risks:
    • In case the investor has chosen to borrow shares from the Greek Stock Exchange authority in order to sell them on the spot market, the investor must be aware that the Greek Stock Exchange authority may at any time request the return of the shares borrowed by the investor. The risk in this case arises from the possibility that the price of the share on the spot market at the time of the request for its return is higher than the price at which it was sold.
    • In case the investor has chosen to borrow shares, he/she should be aware that when requesting the return of the shares, the Greek Stock Exchange authority may return the shares in parts over a period of a few days. The risk arises from the potential negative difference between the price of the shares at the time they are returned and the price they had when they were requested to be returned.
    • An investor who sells short futures that require settlement by physical delivery or sells options without holding the corresponding underlying instruments assumes the risk that if the market moves in the opposite direction to his expectations, his losses are potentially unlimited. A particular risk is inherent in the case of a short call of the American type where the buyer can exercise these rights at any time so that the seller, who does not hold the corresponding underlying instruments, has assumed a very high risk with theoretically unlimited losses.