An options contract offers the buyer the right to buy, not the obligation to buy at the specified price or date. Options are a type of derivative product. They can be used as: Though they have their advantages, trading in options is more complex than trading in regular shares.
It calls for a good understanding of trading and investment practices as well as constant monitoring of market fluctuations to protect against losses.
Just as futures contracts minimize risks for buyers by setting a pre-determined future price for an underlying asset, options contracts do the same however, without the obligation to buy that exists in a futures contract.
Unlike the buyer in an options contract, the seller has no rights and must sell the assets at the agreed price if the buyer chooses to execute the options contract on or before the agreed date, in exchange for an upfront payment from the buyer. There is no physical exchange of documents at the time of entering into an options contract. The transactions are merely recorded in the stock exchange through which they are routed. When you are trading in the derivatives segment, you will come across many terms that may seem alien.
Here are some Options-related jargons you should know about. These are the different strike prices at which an options contract can be traded.
These are determined by the exchange on which the assets are traded. There are typically at least 11 strike prices declared for every type of option in a given month - 5 prices above the spot price, 5prices below the spot price and one price equivalent to the spot price.
Following strike parameter is currently applicable for options contracts on all individual securities in NSE Derivative segment: The strike price interval would be: A future date on or before which the options contract can be executed. Options contracts have three different durations you can pick from:.
American and European Options: Please note that in Indian market only European type of options are available for trading. The standard lot size is different for each stock and is decided by the exchange on which the stock is traded. Open Interest refers to the total number of outstanding positions on a particular options contract across all participants in the market at any given point of time.
Open Interest becomes nil past the expiration date for a particular contract. Let us understand with an example: If trader A buys Nifty options from trader B where, both traders A and B are entering the market for the first time, the open interest would be futures or two contract. The next day, Trader A sells her contract to Trader C. Now, if trader A buys more Nifty Futures from another trader D, the open interest in the Nifty Futures contract would become futures or 4contracts.
Call options usually become more valuable as the value of the underlying asset increases. The Put Option gives the holder the right to sell a particular asset at the strike price anytime on or before the expiration date in return for a premium paid up front.
Since you can sell a stock at any given point of time, if the spot price of a stock falls during the contract period, the holder is protected from this fall in price by the strike price that is pre-set. This explains why put options become more valuable when the price of the underlying stock falls. Similarly, if the price of the stock rises during the contract period, the seller only loses the premium amount and does not suffer a loss of the entire price of the asset.
This means, under this contract, Rajesh has the rights to buy one lot of Infosys shares at Rs per share any time between now and the month of May. He paid a premium of Rs per share. He thus pays a total amount of Rs 25, to enjoy this right to sell.
Now, suppose the share price of Infosys rises over Rs 3, to Rs , Rajesh can consider exercising the option and buying at Rs 3, per share. He would be saving Rs per share; this can be considered a tentative profit.
However, he still makes a notional net loss of Rs 50 per share once you take the premium amount into consideration. For this reason, Rajesh may choose to actually exercise the option once the share price crosses Rs 3, levels. Otherwise, he can choose to let the option expire without being exercised. Rajesh believes that the shares of Company X are currently overpriced and bets on them falling in the next few months. Since he wants to secure his position, he takes a put option on the shares of Company X.
Rajesh buys shares of Company X Put at a strike price of and pays Rs 30 per share as premium. His total premium paid is Rs 30, If the spot price for Company X falls below the Put option Rajesh bought, say to Rs ; Rajesh can safeguard his money by choosing to sell the put option. He will make Rs 50 per share Rs minus Rs on the trade, making a net profit of Rs 20, Rs 50 x shares — Rs 30, paid as premium.
Alternately, if the spot price for Company X rises higher than the Put option, say Rs ; he would be at a loss if he decided to exercise the put option at Rs So, he will choose, in this case, to not exercise the put option. In the process, he only loses Rs 30, — the premium amount; this is much lower than if he had exercised his option.
We saw that options can be bought for an underlying asset at a fraction of the actual price of the asset in the spot market by paying an upfront premium. The amount paid as a premium to the seller is the price of entering an options contract. The price of an Option Premium is controlled by two factors — intrinsic value and time value of the option. This is because contracts with longer expiration periods give the holder more flexibility on when to exercise their option.
This longer time window lowers the risk for the contract holder and prevents them from landing in a tight spot. At the beginning of a contract period, the time value of the contract is high. If the option remains in-the-money, the option price for it will be high. If the option goes out-of-money or stays at-the-money this affects its intrinsic value, which becomes zero.
In such a case, only the time value of the contract is considered and the option price goes down. As the expiration date of the contract approaches, the time value of the contract falls, negatively affecting the option price.
In this section, we understood the basics of Options contracts. In the next part, we go into details about Call options and Put options. Existing customers can send in their grievances to service. No need to issue cheques by investors while subscribing to IPO. Just write the bank account number and sign in the application form to authorise your bank to make payment in case of allotment.
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About Us Why Join Us? What is Options Trading? Options help you profit from changes in share prices without putting down the full price of the share. You get control over the shares without buying them outright.
They can also be used to protect yourself from fluctuations in the price of a share and letting you buy or sell the shares at a pre-determined price for a specified period of time. About Options Just as futures contracts minimize risks for buyers by setting a pre-determined future price for an underlying asset, options contracts do the same however, without the obligation to buy that exists in a futures contract.
About Options When you are trading in the derivatives segment, you will come across many terms that may seem alien. The upfront payment made by the buyer to the seller to enjoy the privileges of an option contract. The pre-decided price at which the asset can be bought or sold. Options contracts have three different durations you can pick from: Previous Chapter Next Chapter. Register for our Newsletter Meaningful Minutes. Why Capital gains report?More...