An extension of the option market whereby the options, rather than the contracts to which they relate, are bought or sold before they expire. There are specific and regulated markets for dealing in traded options.
The principal advantage of the traded option over the traditional option within the futures market is that the link between the person taking the option and the ultimate vendor or purchaser of the commodity is dispensed with and the option itself is traded as if it were a commodity. The person acquiring the option needs only to pay a predetermined premium on it and, when that option is afterwards resold, any resultant profit or loss is restricted to the movement in the premium, which will be a function of the current state of the market. Each traded option market is governed by a central authority which exists partly to buy in options when no other purchaser can be found.
These traded options can be contrasted with traditional options, where the holder must cover his position by hedging, e.g. a person holding an option to buy covers himself by seeking out an option to sell, which will minimize any possible loss.
|Reference: The Penguin Business Dictionary, 3rd edt.|