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OPTIONS CONTRACT INTRODUCTION

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What are Options?

Options are derivative products which gives a trader an option but not obligation to buy or sell a
stock at a particular price and during a particular time period. A trader gets the option to buy or sell
a stock at a particular price by paying an upfront amount for the option known as Premium.

Options are used to profit from changes in the stock prices without putting down full price value of
the stock. Options give a control over a share without actually owning it. Options are also used to
hedge your assets against the price fluctuations of the shares in the market.

Option contracts are similar to futures contract except for a difference that a futures contract has
to be executed on expiry while an options contract gives an option to the buyer whether to
exercise or not.

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calculated by exchange depending on Underlying Stock, Strike Price and Duration of Option
Contract.
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1/28/2021 Options Contract Introduction
Choosing Options based on market view
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If a trader has a Bullish view or he believes markets will go up then he can;
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a. Buy a Call Option – Right to buy a share but not an obligation to buy. If a Call option is bought
Derivatives say for Strike Price of 100 and the price rises to 110, the call option buyer can exercise his right to
buy at 100 and sell the same in the market at 110. Thus the profit is 10 minus premium. But if the
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Price falls to 90, the Call option buyer only loses premium.
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b. Sell a Put Option – Obligation to buy a share at Put option strike price. If a Put option is sold
say for Strike Price of 100 and the price rises to 110, the put option buyer will not exercise his right
to sell. The Put option seller will earn premium and need not pay anything to option buyer. If Price
falls to 90, the Put option seller will lose 10 minus premium amount he received.
1
BEGINNERS G… If a trader has a Bearish view or he believes markets will go down then he can; 59

a. Buy a Put Option – Right to sell a share but not an obligation to sell. If a Put option is bought
2 DERIVATIVES … say for Strike Price of 100 and the price falls to 90, the put option buyer can exercise his right to 44
sell at 100 and buy the same in the market at 90. Thus the profit is 10 minus premium. If the Price
rises to 110, the Put option buyer only loses premium.

3 FUTURES CO… b. Sell a Call Option – Obligation to sell a share at Call option strike price. If a Call option is sold
say for Strike Price of 100 and the price falls to 90, the call option buyer will not exercise his right
to buy. The Call option seller will earn premium and need not pay anything to option buyer. If Price
rises to 110, the Call option seller will lose 10 minus premium.
4
OPTIONS CO… Understanding Strike Price

The Strike Price is a price at which the Option trade is entered into; Strike Price can be In the
Money, At the Money and Out of the Money

For a Call Option

a. In the Money Strike Price – Strike Price is less than Market Price. It has a higher premium
amount as the probability to make profit from the option trade is higher.

b. At the Money Strike Price – Strike Price is equal to Market Price. It has a lower premium as
compared to In the Money option as the probability to make profit from the option trade is lower
than ITM.

c. Out of the Money Strike Price – Strike Price is more than Market Price. It has lowest premium
as the probability to make profit from the option trade is lowest.

For a Put Option

a. In the Money Strike Price – Strike Price is more than Market Price. It has a higher premium
amount as the probability to make profit from Option trade is higher.

b. At the Money Strike Price – Strike Price is equal to Market Price. It has a lower premium as
compared to In the Money option as the probability to make profit from Option trade is lower than
ITM.

c. Out of the Money Strike Price – Strike Price is less than Market Price. It has lowest premium as
the probability to make profit from Option trade is lowest.

Understanding Break-even point

It is point of no profit and no loss and beyond this point an option trader earns profit.

Understanding Option Payoff

a. For Call Option - If the Price moves up Option buyer gains and seller losses and if the price
moves down the seller gains and buyer losses.

b. For Put Option - If the Price moves down Option buyer gains and seller loses and if the price
moves up seller gains and buyer loses.

Volume

In Options when there is 1 Buyer and 1 Seller who trade, then it translates into Volume of 1 trade.

Open Interest

Number of active trades in the market tells us about the volume of Open Interest in the market.

Open Interest is an indicator which tells us a viewpoint of Options contract.

They change every day as market acts to daily news and the view of market direction whether it
will move up or down changes on a daily basis.

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Option Contract gives the buyer the right, but he is no obligated to exercise if the trade is not in
Profit

1
BEGINNERS G… For this right the buyer pays premium to seller
If the market is moving up, down or sideways, the option trader gets opportunity to earn in all
59

market situations

DERIVATIVES …
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