IPO Insight

Options Terminology

Options Terminology

Table of Contents

Options Basics

  •  Options emerged as a financial instrument, which restricted the losses with a provision of unlimited profits on buy or sell of underlying asset.
  • An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying asset on or before a stated date/day, at a stated price, for a price.
  •  The party taking a long position i.e. buying the option is called buyer/ holder of the option and the party taking a short position i.e. selling the option is called the seller/ writer of the option.

Types of Options Contract

Options may be categorized into two main types:‐

  • Call Options
  • Put Options

Call Options Contract

Option, which gives buyer a right to buy the underlying  asset, is called Call option

Put Options Contract

The buyer of a put option has the right to sell the underlying asset for a certain price.

Options Terminology

Options Terminology
  • Index option: These options have index as the underlying asset. For example options on Nifty, Sensex, etc.
  • Stock option: These options have individual stocks as the underlying asset. For example, option on ONGC, NTPC etc
  • Buyer of an option: The buyer of an option is one who has a right but not the obligation in the contract
  • Writer of an option: The writer of an option is one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer of option exercises his right.
  • American option: The owner of such option can exercise his right at any time on or before the expiry date/day of the contract.
  • European option: The owner of such option can exercise his right only on the expiry date/day of the contract. In India, Index options are European.
  • Option price/Premium: It is the price which the option buyer pays to the option seller.
  • Lot size: Lot size is the number of units of underlying asset in a contract. Lot size of Nifty option contracts is 75.
  • Expiration Day: The day on which a derivative contract ceases to exist. It is the last trading date/day of the contract. Like in case of futures, option contracts also expire on the last Thursday of the expiry month
  • Spot price (S): It is the price at which the underlying asset trades in the spot market.
  • Strike price or Exercise price (X): Strike price is the price per share for which the underlying security may be purchased or sold by the option holder.
  • In the money (ITM) option: This option would give holder a positive cash flow, if it were exercised immediately. A call option is said to be ITM, when spot price is higher than strike price. A put option is said to be ITM when spot price is lower than strike price.
  • At the money (ATM) option: At the money option would lead to zero cash flow if it were exercised immediately. Therefore, for both call and put ATM options, strike price is equal to spot price.
  • Out of the money (OTM) option: Out of the money option is one with strike price worse than the spot price for the holder of option. In other words, this option would give the holder a negative cash flow if it were exercised immediate. A call option is said to be OTM, when spot price is lower than strike price. And a put option is said to be OTM when spot price is higher than strike price
  • Intrinsic Value: For an option, intrinsic value refers to the amount by which option is in the money i.e. the amount an option buyer will realize, before adjusting for premium paid, if he exercises the option instantly. Therefore, only in‐the‐money options have intrinsic value whereas at‐the‐money and out‐of‐the‐money options have zero intrinsic value.
  • Time value: It is the difference between premium and intrinsic value, if any, of an option. ATM and OTM options will have only time value because the intrinsic value of such options is zero. The intrinsic value of an option can never be negative.
    Open Interest: As discussed in futures section, open interest is the total number of option contracts outstanding for an underlying asset.
  • Exercise of Options : In case of American option, buyers can exercise their option any time before the maturity of contract. All these options are exercised with respect to the settlement value/ closing price of the stock on the day of exercise of option.
  • Assignment of Options : Assignment of options means the allocation of exercised options to one or more option sellers. The issue of assignment of options arises only in case of  American options because a buyer can exercise his options at any point of time.

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Derivatives Analysis

Basic Concept of Derivatives

  • Concept of Risk Management
  • Introduction to Derivatives
  • Origin of Derivatives
  • Types of Derivatives Products
  • Index Derivatives
  • Participant of Derivatives Market
  • Benefits & Limitation
  • Basics of Forward Markets
  • Futures Contract
  • Future vs Forward
  • Application of Futures
  • Option Terminology
  • Futures Pricing
  • Future vs Options
  • Weekly Options & Its Interpretation
  • Binary Options
  • Top Ten Mistakes By Optional Traders
  • Option Pricing
  • Hedge Strategy Using Options
  • Application of Options

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