Mechanism of Option Trading

Options are the most recent and evolved contracts. Options have allowed both theoreticians as well as practitioners to explore a wide range of possibilities for engineering   different and some times exotic pay off profiles. Option contracts help a hedger reduce his risk with a much wider variety of strategies.

An option gives the holder of the option the right to do something in the future. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves or are obliged to meet their commitments as specified in the contract. Whereas it costs nothing (Except Margin Requirements)  to enter into a futures contract, the purchase of an option requires up-front payment. This article first introduces key terms which will enable the reader to understand option terminology. Afterward futures have been compared with options and then payoff profiles of options contracts have been defined.

Index Options:- index options have the index as the underlying. They can be European or American. To know more about index option tips check on our page.

Stock options:- They are the options on individual stocks and give the holder the right to by or sell shares at the specified price. They can be European or American.

Buyer of an option:- The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.

Writer of an option:- The writer of a call/put option is the who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.

There are two basic type of options, Call options and Put options.

Call Option. It gives the holder right but not obligation to buy an asset by a certain date for a certain price.

Put Option. It gives the holder the right but not obligation to sell an asset by a certain date for a certain price.

Options Price/Premium: It is the price which the option buyer pays to the option seller/writer. It is also referred as the option premium.

Expiration Date: The date specified in the option contract is known as the expiration date, the exercise date, the strike date or the maturity.

Strike Price: the price specified in the options contract is known as the strike price or the exercise price.

American Options: These can be exercised at any time upto the expiration date.

Complete Understand About Options

European options: These can be exercised on the expiration date itself. European options are easier to analyze than the  American options and properties of an American option are frequently deduced from those of its European counterpart. If you are still confused and want to know about Bank nifty option tips, check here .

In-the-money option: An in-the-money option would lead to positive cash flow to the holder if it were exercised immediately. A call option of an index is said to be in the money when the current index stands at a level higher than the strike price. i.e. Spot Price >strike price. if the index is much higher than the strike price, the call is said to be deep in the money. In the case of put is in-the-money if the index is below the strike price.

Time value of an option: The time value of an option is the difference between its premium and its intrinsic value. Both call and puts have the time value. The longer the time to expiration, the greater is an option’s time value, all else equal. At expiration, an option has no time value.