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Examples explaining the definition of ‘option�

Example 1

A company buys an over the counter (OTC) oil cap. This is an option product, whose underlying subject matter is crude oil. »Ê¹ÚÌåÓýapp contract gives the company the right, but not the obligation, to fix the price of a notional cargo of crude oil at a specified price (the strike price) for a specified period. If the average oil price over the period goes above the strike price, the company will exercise the option. »Ê¹ÚÌåÓýapp writer of the option will then make a payment to the company based on the difference between the strike price and the market price of the oil. »Ê¹ÚÌåÓýapp crude oil cargo, which forms the underlying subject matter, is purely notional and there is no provision in the contract for any oil to be delivered.

»Ê¹ÚÌåÓýapp contract meets the conditions in CTA09/S580(2), so for the purposes of Part 7 CTA09 the contract is classed as a contract for differences (CFD) rather than an option.

Example 2

A company buys an OTC currency option, giving it the right, but not the obligation, to purchase US$1m for £600,000 on a specified future date. At the exercise date, US$1m can be bought for £550,000 in the spot market, so the company does not exercise the option. »Ê¹ÚÌåÓýapp contract provides for the delivery of property - the dollars being property for this purpose - so it does not meet the CTA09/S580(2) conditions. It is classified as an option for Part 7 purposes. This would still be the case if, as an alternative to the option writer delivering the dollars, the contract provided for a cash settlement in sterling. It would only be debarred from being an option if gross settlement (i.e. an exchange of dollars for sterling) was not offered at all.

Example 3

This example illustrates a case where S580(2) is overridden by other legislation.

Company X issues a security of £100 nominal value, with the following terms: on maturity, the holder of the security is entitled to receive £100 or, if greater, the value of 10 £1 shares in X. »Ê¹ÚÌåÓýapp holder has no right to subscribe for, or receive, shares in X as an alternative.

Company X accounts for the security as a host contract (treated as a debtor loan relationship) plus an embedded derivative. For the purposes of CTA09/S652, this embedded derivative is characterised as an option, even though it can only be settled in cash. This is because, for the issuer of the security, CTA09/S652(7) construes ‘option� as though the restriction in CTA09/S580(2) was omitted.

This means that the statutory provisions (S654 and S655) relevant to options embedded in debtor loan relationships apply in this case, just as they do to a more conventional convertible security where company X may be obliged to transfer or issue shares (see CFM55400+ for more about these rules).

Note, however, that there is no such extension of the meaning of ‘option� for CTA09/S645, the section dealing with creditor relationships containing embedded options (CFM55220). So the security in this example will not, from the holder’s perspective, come within the special rules for convertible securities.