Which of the following is NOT true. An options contract is a contractual agreement between two parties. is based on the value of an underlying security. obliges the holder to exercise it at the expiration date. gives a trader the right to buy or sell the underlying security.
The Correct Answer and Explanation is:
The correct answer is:
“obliges the holder to exercise it at the expiration date.”
Explanation
An options contract is a financial derivative that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price (called the strike price) on or before a specified expiration date. The key aspect of options is choice—the holder can decide whether or not to exercise the option, depending on whether it is profitable.
There are two main types of options:
- Call options – give the holder the right to buy the underlying asset.
- Put options – give the holder the right to sell the underlying asset.
Let’s review each statement in the question:
- “An options contract is a contractual agreement between two parties.”
This is true. One party is the buyer (holder) of the option, and the other is the seller (writer) who must fulfill the contract if the option is exercised. - “An options contract is based on the value of an underlying security.”
This is also true. The price and value of the option are derived from an asset like a stock, index, or commodity. - “An options contract obliges the holder to exercise it at the expiration date.”
This is NOT true. The holder has the right, not the obligation, to exercise the option. If exercising is not beneficial (e.g., the option is “out of the money”), the holder can choose to let it expire worthless. - “An options contract gives a trader the right to buy or sell the underlying security.”
This is true. The option gives a trader the ability to take action if it is in their favor.
Therefore, the false statement is the one about obligation to exercise, which misrepresents the nature of options.
