What traders and firms use options for
Question
Give the main purposes for which market participants buy or sell options.
Short answer
Hedging, leveraged speculation, trading volatility, earning premium and shaping payoffs. Options let a holder insure against adverse moves (a put on a portfolio, a cap on borrowing costs), take directional views with limited downside and leverage, express views on volatility rather than direction, generate income by writing options, and build custom payoff profiles for structured products, as well as manage tax or regulatory constraints.
Adapted from Joshi, Denson & Downes, Quant Job Interview Questions and Answers, Q2.32, p.19; question and answer rewritten by SelfMadeQuant.com.
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Open the worked solutionLessons behind this question
- Market Model and Risk-Neutral Valuation
- Option Mechanics: Calls, Puts, Moneyness, Intrinsic Value, and Exchange vs. OTC Markets
- Option Trading Strategies: Spreads, Combinations, and Payoff Engineering
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