What options are all about?

An option is a contract giving the buyer the right—but not the obligation—to buy (in the case of a call) or sell (in the case of a put) the underlying asset at a specific price on or before a certain date

Option is a derivative of any underlying asset. Before learning options we need to understand briefly what are derivatives.

Derivatives are the segment in the stock market which derive their value from an underlying asset like Index, currency, stock, commodity etc. Derivatives are used for hedging purposes and speculation (trading). There are four types of derivatives that are: Futures, Forwards, Swaps and Options. In Indian Stock Market forwards and swaps are not traded.

Coming to the question, Options also derive their values from an underlying asset unlike futures options have Call option and Put option.

1. Call options (CE)

Calls give the buyer the right, but not the obligation, to buy the underlying asset at the strike price specified in the option contract. Traders buy calls when they believe the price of the underlying asset will increase and sell calls if they believe it will decrease.

2. Put options (PE)

Puts give the buyer the right, but not the obligation, to sell the underlying asset at the strike price specified in the option contract. The writer (seller) of the put option is obligated to buy the asset if the put buyer exercises their option. Traders buy puts when they believe the price of the underlying asset will decrease and sell puts if they believe it will increase.

Also there are many strike prices of that particular underlying asset which are differentiated with each other with a specific intervals, for suppose the strike prices of nifty50 are 18000, 18050, 18100, 18150 etc.

Moneyness of strike prices

There are three types of strike prices ATM, OTM, and ITM.

ATM: The strike price near to the market price is called the(ATM) At The Money strike price e.g. if Nifty is trading at 18020 the ATM strike price will be 18000.

OTM: For a call option the strike prices above the market price (Spot Price) are Out of The Money (OTM) strike prices.

For a put option the strike prices below the spot price are termed as Out of The Money (OTM) strike prices.

ITM: For a call option the strike prices below the spot price are termed as In The Money (ITM) strike prices.

For a put option the strike prices above the spot price are termed as In The Money (ITM) strike prices.

The price of a option contract is decided by the Intrinsic and time value of that particular contract. The price of a option contract is known as Premium. We can buy as well as we can sell (short) an option, also we can hold it till the maturity (expiry).

Option Trading

If our view is bullish on the market we can buy a call option or we can sell (short) a put option

If our view is bearish on the market we can buy a put option or we can sell (short) a call option

On buying an option contract we need to pay the premium, but on selling (writing) an option contract we receive the premium.

Buying is easy to understand but what about selling (writing or short selling): It means we first sell a option contract then buy it back, first selling on higher price and buying it back on low price the difference is will be our profit.

Profit

There is a quick profit in the option trading along with this there is a huge risk. It is the toughest segment in the stock market.

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