The purpose of this article is to introduce our readers with the basic concepts of Options. People having a good knowledge of options may find this article a simplified version but that is my main motive of writing this article. I would cover the intermediary & advanced option concepts in my coming articles. I have covered the basic structure of the Option contracts in this article to achieve ease of understanding.
What is an Option?
What is an Option?
An Option is a derivative instrument or a financial product under the terms of which you have an option to buy or sell a particular security or other financial instrument as specified in the Option contract. This security or other financial instrument is called as “Underlying Instrument” of the Option on which the Option is based.
The option contract is well structured & highly precise regarding the period of option contract for which the option would be in force, the price at which the underlying instrument would be bought or sold, how the rights & obligations under the option contract would be settled & so on.
Usually we have a particular date for any Option contract till the time which the Option to buy or sell the underlying security would be available to the investor. This date is called as “option expiry date”. After the expiry date the rights & obligations under the Option contract are dissolved & cease to remain in force.
The price at which the underlying would be bought or sold is known as “exercise price” or “Strike Price”. In case the buyer of the option decides to exercise the right to buy or sell the underlying instrument then that needs to be done at exercise price only.
Parties to Option Contract:
There are two parties involved in any option contract i.e. buyer & seller of the Option. The buyer of the option contract has a right but no obligation to buy or sell the underlying instrument on or before the expiration date at pre decided price i.e. the strike price
Parties to Option Contract:
There are two parties involved in any option contract i.e. buyer & seller of the Option. The buyer of the option contract has a right but no obligation to buy or sell the underlying instrument on or before the expiration date at pre decided price i.e. the strike price
The seller of the option is also called as “option writer”. The option seller receives a payment from the option buyer in return for his giving the right to buy or sell the underlying instrument. This amount is called as “Option Premium”.
Classification of Options:
Options can be classified as “Call option” & “Put Option”
Call Option:
A Call Option is an Option which confers the buyer a right but not the obligation to buy the underlying instrument on or before the option expiry date at strike price.
Classification of Options:
Options can be classified as “Call option” & “Put Option”
Call Option:
A Call Option is an Option which confers the buyer a right but not the obligation to buy the underlying instrument on or before the option expiry date at strike price.
Put Option:
A put option is an option that gives the buyer a right but not the obligation to sell the underlying instrument on or before the option expiry date at strike price.
In both Call & Put Options if the buyer decides to exercise the right to buy or sell the underlying instrument the seller is under obligation to sell or buy, as the case may be, the underlying instrument to the buyer.
As can be seen from above the buyer of the option has always a right to buy or sell the underlying instrument. So if the price of the underlying instrument moves in a direction not favorable to the buyer of the option the buyer may simply waive the right to buy or sell the underlying & the option would expire on the expiry date. In that case the only loss to the buyer would be the Option premium paid at the time of acquiring the option.
A put option is an option that gives the buyer a right but not the obligation to sell the underlying instrument on or before the option expiry date at strike price.
In both Call & Put Options if the buyer decides to exercise the right to buy or sell the underlying instrument the seller is under obligation to sell or buy, as the case may be, the underlying instrument to the buyer.
As can be seen from above the buyer of the option has always a right to buy or sell the underlying instrument. So if the price of the underlying instrument moves in a direction not favorable to the buyer of the option the buyer may simply waive the right to buy or sell the underlying & the option would expire on the expiry date. In that case the only loss to the buyer would be the Option premium paid at the time of acquiring the option.
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