Definition of options trading
A contract is called OTM when the strike price of a call option is above the spot price of the underlying asset. In case of a Put option, a contract is called Out of Money when the strike of the underlying asset is below the spot price of an option contract. For call options, the further away the strike price from the spot price, the economical the option. The following table shows the various strike price and the premiums and other factors for a stock trading at Rs Conversely, for put options, the following table shows the various strike price and the premiums and other factors for a stock trading at Rs Moneyness in simple terms explains the amount of money the option holder was to make if he were to exercise his right immediately.
It simply explains the intrinsic value i. In financial terms, the expiration date of an option contract is the last date on which the holder of the option may exercise it. If the stock price is above the Put option strike price, the option expires worthless. The weekly options expire every Thursday in Indian Equity Market and the monthly options expire on the last trading Thursday of every month. If Thursday is a holiday, then the options expire the previous day. The option premium is the fees paid to the option seller by the option buyer for having a right on an underlying asset before expiry.
If the option expires In the Money then the option buyer has the right to exercise the option contract. If the option expires Out of money, then the option buyer stands to lose to money i. An option buyer buys call at Rs. Upon expiry, if the price of XYZ id , then the income made by the buyer is Rs 30 Spot price — strike price — option premium. Again if the price of XYZ shares upon expiry is Rs. Following is the calculation to explain:. Here, the total Income of Option Buyer: Rs. So the intrinsic value will be 0.
What are Stock Options? • Definition & Examples • Benzinga
The expiry is 30th Jan last Thursday. The premium is Rs 4 and one market lot has 7, shares. Assume there are two traders — Trader A and Trader B. Trader A wants to buy option buyer and trader B wants to sell write this agreement. Here is how the money movement will happen. However, this does not mean that Trader B should have shares with him on 30th Jan. Options are cash-settled in India. This simply means on the last day if Trader A wants to use his right to exercise his option then Trader B is obligated to pay just the cash differential.
Another way to look at it is that the option buyer is making a profit of Rs. Because the option is cash-settled, instead of giving the option buyer shares, the option seller directly gives him the cash equivalent of the profit he would make, which means Trader A would receive. Of course, the option buyer had initially spent Rs. The fact that one can make such a large exponential return is what makes options an attractive instrument to trade. This is one of the reasons why Options are one of the most favorite trading instruments amongst Traders.
Also read: What is Bank Nifty?
Definition of 'Call Option'
Here are the key takeaways from this post:. Connect with Hitesh over Twitter here! I mostly read your articles and i like your ideas on this topic. Many peoples are searching for the trading accounts and all. I will suggest to all that read this amazing blog. The option is not exercised because the option buyer would not buy the stock at the strike price higher than or equal to the prevailing market price. However, if the market share price is more than the strike price at expiry, the seller of the option must sell the shares to an option buyer at that lower strike price.
In other words, the seller must either sell shares from their portfolio holdings or buy the stock at the prevailing market price to sell to the call option buyer. The contract writer incurs a loss. How large of a loss depends on the cost basis of the shares they must use to cover the option order, plus any brokerage order expenses, but less any premium they received. As you can see, the risk to the call writers is far greater than the risk exposure of call buyers.
The call buyer only loses the premium. The writer faces infinite risk because the stock price could continue to rise increasing losses significantly.
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- Stock Option Definition?
Put options are investments where the buyer believes the underlying stock's market price will fall below the strike price on or before the expiration date of the option. Once again, the holder can sell shares without the obligation to sell at the stated strike per share price by the stated date. Since buyers of put options want the stock price to decrease, the put option is profitable when the underlying stock's price is below the strike price. If the prevailing market price is less than the strike price at expiry, the investor can exercise the put. They will sell shares at the option's higher strike price.
Should they wish to replace their holding of these shares they may buy them on the open market. Their profit on this trade is the strike price less the current market price, plus expenses—the premium and any brokerage commission to place the orders. The value of holding a put option will increase as the underlying stock price decreases. Conversely, the value of the put option declines as the stock price increases. The risk of buying put options is limited to the loss of the premium if the option expires worthlessly.
Selling put options is also known as writing a contract.
A put option writer believes the underlying stock's price will stay the same or increase over the life of the option—making them bullish on the shares. Here, the option buyer has the right to make the seller, buy shares of the underlying asset at the strike price on expiry. If the underlying stock's price closes above the strike price by the expiration date, the put option expires worthlessly.
The writer's maximum profit is the premium. The option isn't exercised because the option buyer would not sell the stock at the lower strike share price when the market price is more.
Stock Option Basics
However, if the stock's market value falls below the option strike price, the put option writer is obligated to buy shares of the underlying stock at the strike price. In other words, the put option will be exercised by the option buyer. The buyer will sell their shares at the strike price since it is higher than the stock's market value. The risk for the put option writer happens when the market's price falls below the strike price. Now, at expiration, the seller is forced to purchase shares at the strike price. Depending on how much the shares have depreciated, the put writer's loss can be significant.
The put writer—the seller—can either hold on to the shares and hope the stock price rises back above the purchase price or sell the shares and take the loss. However, any loss is offset somewhat by the premium received. Sometimes an investor will write put options at a strike price that is where they see the shares being a good value and would be willing to buy at that price. When the price falls, and the option buyer exercises their option, they get the stock at the price they want, with the added benefit of receiving the option premium.
A call option buyer has the right to buy assets at a price that is lower than the market when the stock's price is rising. The put option buyer can profit by selling stock at the strike price when the market price is below the strike price. In a falling market, the put option seller may be forced to buy the asset at the higher strike price than they would normally pay in the market.
The call option writer faces infinite risk if the stock's price rises significantly and they are forced to buy shares at a high price. You decide to buy a call option to benefit from an increase in the stock's price. The profit on the option position would be As you can see, options can help limit your downside risk. Options spreads are strategies that use various combinations of buying and selling different options for a desired risk-return profile. Spreads are constructed using vanilla options , and can take advantage of various scenarios such as high- or low-volatility environments, up- or down-moves, or anything in-between.
Spread strategies, can be characterized by their payoff or visualizations of their profit-loss profile, such as bull call spreads or iron condors. See our piece on 10 common options spread strategies to learn more about things like covered calls, straddles, and calendar spreads. Options are a type of derivative product that allow investors to speculate on, or hedge against, the volatility of an underlying stock.