FIN 402 CHAP 2 Structure option markets

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In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. North argues that institutions, understood as option traders incur which of the following types of costs or cost set of rules in a society, are key in the determination of transaction costs. In this sense, institutions that facilitate low transaction costs, boost economic growth. Douglass North states that there are four factors that comprise transaction costs — "measurement," "enforcement," "ideological attitudes and perceptions," and "the size of the market.

Transaction costs can be divided into three broad categories: For example, the buyer of a used car faces a variety of different transaction costs. The search costs are the costs of finding a car and determining the car's condition.

The bargaining costs are the costs of negotiating option traders incur which of the following types of costs or cost price with the seller. The policing and enforcement costs are the costs of ensuring that the seller delivers the car in the promised condition.

The idea that transactions form the basis of an economic thinking was introduced by the institutional economist John R. These individual option traders incur which of the following types of costs or cost are really trans-actions instead of either individual behavior or the "exchange" of commodities.

It is this shift from commodities and individuals to transactions and working rules of collective action that marks the transition from the classical and hedonic schools to the institutional schools of economic thinking. The shift is a change in the ultimate unit of economic investigation.

The classic and hedonic economists, with their communistic and anarchistic offshoots, founded their theories on the relation of man to nature, but institutionalism is a relation of man to man. The smallest unit of the classic economists was a commodity produced by labor.

The smallest unit of the hedonic economists was the same or similar commodity enjoyed by ultimate consumers. One was the objective side, the other the subjective side, of the same relation between the individual and the forces of nature. The outcome, in either case, was the materialistic metaphor of an automatic equilibrium, analogous to the waves of the ocean, but personified as "seeking their level. Transactions intervene between the labor of the classic economists and the pleasures of the hedonic economists, simply because it is society that controls access to the forces of nature, and transactions are, not the "exchange of commodities," but the alienation and acquisition, between individuals, of the rights of property and liberty created by society, which must therefore be negotiated between the parties concerned before labor can produce, or consumers can consume, or commodities be physically exchanged".

The term "transaction cost" is frequently thought to have been coined by Ronald Coasewho used it to develop a theoretical framework for predicting when certain economic tasks would be performed by firmsand when they would be performed on the market. However, the term is actually absent from his early work up to the s. While he did not coin the specific term, Coase indeed discussed "costs of using the price mechanism" in his paper The Nature of the Firmwhere he first discusses the concept of transaction costs, and refers to the "Costs of Market Transactions" in his seminal work, The Problem of Social Cost The term "Transaction Costs" itself can instead be traced back to the monetary economics literature of the s, and does not appear to have been consciously 'coined' by any particular individual.

Arguably, transaction cost reasoning became most widely known through Oliver E. Williamson 's Transaction Cost Economics. Today, transaction cost economics is used to explain a number of different behaviours. Often this involves considering as "transactions" not only the obvious cases of buying and sellingbut also day-to-day emotional interactions, informal gift exchanges, etc.

Williamson, one of the most cited social scientist at the turn of the century, [5] was awarded the Nobel Memorial Prize in Economics. According to Williamson, the determinants of transaction costs are frequency, specificityuncertainty, limited rationality, and opportunistic behavior.

At least two definitions of the phrase "transaction cost" are commonly used in literature. Transaction costs have been broadly defined by Steven N. Cheung as any costs that are not conceivable in a " Robinson Crusoe economy"—in other words, any costs that arise due to the existence of institutions. For Cheung, if the term "transaction costs" were not already so popular in economics literatures, they should more properly be called "institutional costs". Starting with the broad definition, many economists then ask what kind of institutions firms, markets, franchisesetc.

Often these relationships are categorized by the kind of contract involved. This approach sometimes goes under the rubric of New Institutional Economics. A supplier may bid in a very competitive environment with a customer to build a widget. However, to make the widget, the supplier will be required to build specialized machinery which cannot be easily redeployed to make other products.

This means that the customer has greater leverage over the supplier such as when price cuts occur. To avoid these potential costs, "hostages" may be swapped to avoid this event. These hostages could include partial ownership in the widget factory; revenue sharing might be another way. Car companies and their suppliers often fit into this category, with the car companies forcing price cuts on their suppliers.

Defense suppliers and the military appear to have the opposite problem, with cost overruns occurring quite often. Technologies like enterprise resource planning ERP can provide technical support for these strategies.

In game theory, transaction costs have been studied by Anderlini and Felli Both parties are needed to create the surplus. Yet, before the parties can negotiate about dividing the surplus, each party must incur transaction costs.

In particular, if a party has large transaction costs but in future negotiations it can seize only a small fraction of the surplus i. It has been shown that the presence of transaction costs as modelled by Anderlini and Felli can overturn central insights of the Grossman-Hart-Moore theory of the firm.

From Wikipedia, the free encyclopedia. It has been suggested that Search cost be merged into this article. Discuss Proposed since December Diseconomy of scale Economic anthropology Herbert A. Simon Interaction cost Market impact cost Market maker Property rights economics Switching costs Theory of the firm Transaction cost analysis. Journal of Law and Economics. These, then, represent the first approximation to a workable concept of transaction costs: Journal of Institutional Economics.

Williamson, Volume 86, Issue 3, Pages September Cooperation, Conflict, and Law. The American Political Science Review. Review of Social Economy. Chriss, "Optimal execution of portfolio transactions" J. Market Microstructure and Liquidity. Retrieved November 27, Transaction costs and option traders incur which of the following types of costs or cost information". Economic theory Econometrics Applied economics. Behavioral economics Computational economics Econometrics Economic systems Experimental economics Mathematical economics Methodological publications.

Ancient economic thought Austrian school of economics Chicago school of economics Classical economics Feminist economics Heterodox economics Institutional economics Keynesian economics Mainstream economics Marxian economics Neoclassical economics Post-Keynesian option traders incur which of the following types of costs or cost Schools overview.

Notable economists and thinkers within economics. Retrieved from " https: Costs Production economics New institutional economics. Articles to be merged from December All articles to be merged Pages using div col with deprecated parameters. Views Read Edit View history. In other projects Wikiquote.

This page was last edited on 4 Aprilat By using this site, you agree to the Terms of Use and Privacy Policy. Assumes hyperrationality and ignores most of the hazards related to opportunism. Analyzes the transaction itself. Describes the firm as a production function a technological construction.

Often assumes that property rights are clearly defined and that the cost of enforcing those rights by the means of courts is negligible. Uses continuous marginal modes of analysis in order to achieve second-order economizing adjusting margins. Analyzes the basic structures of the firm and its governance in order to achieve first-order economizing improving the basic governance structure. Recognizes profit maximization or cost minimization as criteria of efficiency.

Argues that there is no optimal solution and that all alternatives are flawed, thus bounding "optimal" efficiency to the solution with no superior alternative and whose implementation produces net gains. Option traders incur which of the following types of costs or cost Almgren and Neil Chrissand later Robert Almgren and Tianhui Lishowed that the effects of transaction costs lead portfolio managers and options traders to deviate from neoclassically optimal portfolios extending the original analysis to derivative markets [13][14].

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Margin is a very widely used word in financial terms, but it's unfortunately a word that is often very confusing for people. This is largely because it has a number of different meanings, depending on what context it is being used in. In particular, the meaning of the term as used in options trading is very different to the meaning of the term as used in stock trading.

The phrase profit margin is also a common term, and that means something else again. On this page we explain what the term margin means in these different contexts, and provide details of how it's used in options trading.

Profit margin is a term that is commonly used in a financial sense in a variety of different situations. The simplest definition of the term is that it's the difference between income and costs and there are actually two types of profit margin: Gross profit margin is income or revenue minus the direct costs of making that income or revenue. For example, for a company that makes and sells a product, their gross profit margin will be the amount of revenue they receive for selling the product minus the costs of making that product.

Their net margin is income or revenue minus the direct costs and the indirect costs. Investors and traders can also use the term profit margin to describe the amount of money made on any particular investment. For example, if an investor buys stocks and later sells those stocks at a profit, their gross margin would be the difference between what they sold at and what they bought at.

Their net margin would be that difference minus the costs involved of making the trades. Profit margin can be expressed as either a percentage or an actual amount. You may hear people refer to buying stocks on margin, and this is basically borrowing money from your broker to buy more stocks. If you have a margin account with your stock broker, then you will be able to buy more stocks worth more money than you actually have in your account.

If you do buy stocks in this manner and they go down in value, then you may be subject to a margin call, which means you must add more funds into your account to reduce your borrowings. Margin is essentially a loan from your broker and you will be liable for interest on that loan. The idea of buying stocks using this technique is that the profits you can make from buying the additional stocks should be greater than the cost of borrowing the money. You can also use margin in stock trading to short sell stocks.

Margin in futures trading is different from in stock trading; it's an amount of money that you must put into your brokerage account in order to fulfill any obligations that you may incur through trading futures contracts.

This is required because, if a futures trade goes wrong for you, your broker needs money on hand to be able to cover your losses.

Your position on futures contracts is updated at the end of the day, and you may be required to add additional funds to your account if your position is moving against you. The first sum of money you put in your account to cover your position is known as the initial margin, and any subsequent funds you have to add is known as the maintenance margin. In options trading, margin is very similar to what it means in futures trading because it's also an amount of money that you must put into your account with your broker.

This money is required when you write contracts, to cover any potential liability you may incur. This is because whenever you write contracts you are essentially exposed to unlimited risk.

For example, when you write call options on an underlying stock you may be required to sell that stock to the holder of those contracts. If it was trading at a significantly higher price than the strike price of the contracts you had written, then you would stand to lose large sums of money. In order to ensure that you are able to cover that loss, you must have a certain amount of money in your trading account.

This allows brokers to limit their risk when they allow account holders to write options because when contracts are exercised and the writer of those contracts is unable to fulfill their obligations, it's the broker with whom they wrote them that is liable. Although there are guidelines set for brokers as to the level of margin they should take, it's actually down to the brokers themselves to decide.

Because of this, the funds required to write contracts may vary from one broker to another, and they may also vary depend on your trading level.

However, unlike the requirements when trading futures, the requirement is always set as a fixed percentage and it isn't a variable that can change depending on how the market performs. It's actually possible to write options contracts without the need for a margin, and there are a number of ways in which you can do this. Essentially you need to have some alternative form of protection against any potential losses you might incur.

For example, if you wrote call options on an underlying stock and you actually owned that underlying stock, then there would be no need for any margin. This is because if the underlying stock went up in value and the contracts were exercised you would be able to simply sell the holder of the contracts the stock that you already owned.

Although you would obviously be selling the stock at a price below the market value, there is no direct cash loss involved when the contracts are exercised. You could also write put options without the need for a margin if you held a short position on the relevant underlying security. It's also possible to avoid the need for a margin when writing options by using debit spreads. When you create a debit spread, you would usually be buying in the money options and then writing cheaper out of the money options to recover some of the costs of doing so.

Assuming you buy the same amount of contracts as you write, your losses are limited and there is therefore no need for margin. There are a number of trading strategies that involve the use of debit spreads, which means there are plenty of ways to trade without the need for margin. However, if you are planning on writing options that aren't protected by another position then you need to be prepared to deposit the required amount of margin with your options broker.

In reality, even if you are trading futures options this isn't something you really need to concern yourself with. However, you may hear the term used and it can be useful to know what it is. The SPAN system was developed by the Chicago Mercantile Exchange in , and is basically an algorithm that's used to determine the margin requirements that brokers should be asking for based on the likely maximum losses that a portfolio might incur.

SPAN calculates this by processing the gains and losses that might be made under various market conditions. As we have mentioned, it's far from essential that you understand SPAN and how it's calculated, but if you do trade futures options then the amount of margin your broker will require will be based on the SPAN system. Full Explanation of Margin Margin is a very widely used word in financial terms, but it's unfortunately a word that is often very confusing for people.

Section Contents Quick Links. Profit Margin Profit margin is a term that is commonly used in a financial sense in a variety of different situations. Margin in Stock Trading You may hear people refer to buying stocks on margin, and this is basically borrowing money from your broker to buy more stocks. Margin in Futures Trading Margin in futures trading is different from in stock trading; it's an amount of money that you must put into your brokerage account in order to fulfill any obligations that you may incur through trading futures contracts.

Margin in Options Trading In options trading, margin is very similar to what it means in futures trading because it's also an amount of money that you must put into your account with your broker.

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