The underlying asset might be a stock, a foreign currency, a treasury bill, a commodity such as aviation fuel, or even another derivative. They are traded on organized exchanges around the world, in which case the contracts are standardized with respect to most or all of the key variables. A forward contract is an agreement between two parties for one to buy from the other a specified quantity of a particular asset at an agreed price, the delivery price, at a specified time and place. At the time that the contract is agreed upon, the delivery price is set so that the value of the forward contract is zero. In other words, no cash is exchanged at the time of inception of the contract.
Options differ from forwards and futures in two main ways.
Firstly, a premium is paid by the purchaser of the option to the writer of the option. When the transaction can only take place at a specified time, the option is referred to as a European option. In distinction, when the transaction can take place at any time between the inception time of the option and an agreed expiration time, it is referred to as an American option. European options are usually valued using the Black and Scholes option formula. Because of the possibility of early exercise, American options are more difficult to value, the most common method being due to Cox, Ross and Rubinstein.