Options Basics Explained : A Beginners Guide

Options Introduction

We are on a drive to make you future and options expert and in this league, we will be providing you a daily lesson wrt Options and trading strategies that can be implemented by you to make money in the market. So, do not miss any of the articles as we are starting from the basics and will build on it.

An Option is a financial derivative instrument that gives the right but not the obligation to the option holder to either sell or buy an underlying asset at a pre-specified date i.e. expiry date and at a pre-specific price i.e. the strike price. The option seller has the obligation to fulfill the transaction as and when the option holder demands (exercise or not to exercise decision rests with the option holder). The option writer receives a reward, for sale of this right to the option buyer, known as ‘Premium’. However, as a word of caution that you should enter in the Selling of Options only if you have deep pockets else keep yourself away from pure selling unless it is accompanied by some sort of hedging regarding which we will be discussing subsequently.

Two types of Option:

1. Call Option

A Call Option gives an option buyer (then holder) the right but not the obligation to buy the underlying asset (stock, commodity, currency, etc.) at a pre-specific price (strike price) and at a pre-specified date (expiry date).

2. Put Option

A Put Option gives an option buyer (then holder) the right but not the obligation to sell the underlying asset (stock, commodity, currency, etc.) at a pre-specific price (strike price) and at a pre-specified date (expiry date).

Duration of an Option:

In India, options can be traded for 3 months:

1. Near Month: July (current on-going month)
2. Next Month: August (next month)
3. Far Month: September (next to next month)

Moneyness of an Option: Comparing the spot price with the strike price at expiry date, Options will be classified under 3 categories:

Call Option Moneyness Put Option

Call Option                                 Moneyness                                Put Option

Strike Price< Spot Price             In The Money                            Strike Price > Spot Price
Strike Price = Spot Price           At The Money                             Strike Price = Spot Price
Strike Price > Spot Price           Out of the Money                        Strike Price < Spot Price

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