What is an option?
Option is a financial product whose price is based on its underlying instrument (or product) underlying instrument can be Index (Nifty, Jr.Nifty, Bank Nifty etc) stock, currency etc.
In other words - Options are derivative instruments, meaning that their prices are derived from the price of another security. More specifically, options prices are derived from the price of an underlying stock, index, currency etc
Following are few examples of options,
1. “Nifty option” is an Index option whose value is based on Nifty Index.
2. “Bank Nifty” option is also an Index option whose value is based on Bank Nifty Index.
3. Reliance industries option is a stock option whose value is based on Reliance stock.
The stocks and indices eligible for futures trading are also eligible for options trading.Common terms to know
Buying and selling of options consist of strike price, expiry date and its value.
Options Strike Price
It is also called as exercise price. Strike price is the target price at which trader wish to sell or buy the options.
Options Expiry
Options get expired every last Thursday of the month.
In India options are available for trading of maximum 3 months.
For example - If current month is January then options available for trading will be January, February and March.
Current month options have more participation (traders) (In option language it is called as liquid) and goes on decreasing as you move towards buying next month options.
Options Value
It is the price which trader/investor pays to buy or sell an option.
As you precede reading you will understand more about these terms
Types of options
Options are brought in two ways,
1. Call option
2. Put option
1. Call option -
Simple meaning - Call option is bought when the underlying (Nifty, Jr.Nifty, Bank Nifty etc or stock ) is expected to go up.
The financial Definition - A call option gives the buyer the right to buy specified quantity of the underlying asset at the strike price on or before expiration date.
Example of Call option
2700 Nifty March call at Rs.90.
Explanation of the above example is as follows
a) In above example you are buying one lot of Nifty March call.
b) Call - It is the option type (call & put are two types of options).
c) 2700 - It is called as strike price. Trader is expecting that the Nifty will reach or cross the strike 2700 so that he can get the profit.
d) Nifty - It is the Nifty Index whose call option you are buying. In other words it is the underlying asset.
e) March - It is the expiry month
f) Rs. 90 - It is called as the value or premium. It is price at which trader is buying the one lot of Nifty March call. It is the price you are paying to buy one Nifty quantity.
One Nifty lot consist of 50 quantity so you are paying total Rs.90 x 50 Qty = Rs.4500 to buy one lot of Nifty call option.
How the trader will get profit?
If the Nifty Index start increasing toward 2700, then its value (Rs.90), will also starts increasing and once the Nifty crosses 2700 then the price starts increasing rapidly because the Nifty has crossed your strike price (which is at Rs.2700).
Shorting call option (Short Sell)
Call option can also be shorted (short sell), but shorting of call requires future derivative margin.
For example - If you are shorting above mentioned Nifty call then you may have to pay Rs. 28,000 (approx at the time of writing this article), which is the margin required for Index future derivative.
The short selling of calls provides the trader/investor the benefit (profit) when the underlying (in above example underlying is Nifty) moves in downward direction
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