Derivative FNO Trading : What is Option and Option Trading

By Abhishek katkar
Derivative FNO Trading : What is Option and Option Trading

What is option trading?

What is option?

Option is a special contract that gives the buyer the right, but not the obligation to buy or sell the shares of the underlying security at a specific price on or before a specific date. Here the owner enjoys right to buy or sell something without obligation to do so.

Obligation: ( having to do something because it is a law or duty or because you have promised)

What is Option Trading

In simple words option trading means you trade in derivative of the underlying assets which (anything from stock, index and currency....) derive their value from the price of other asset.
For example :
Derivatives of the Nifty 50 will derive its value from the price of Nifty 50. here you trade the strike option of nifty that is derivative and their value is derived from, means depends on the Nifty 50.

when you trade you buy one contract of Nifty 50 from the option chain and their value depend on the price of the Nifty 50 movements.

Where you do option trade?

Option trading comes in derivative segment. You can do option trading in stocks, index, commodities, currencies and ETFs.

There are two basic styles of options

The American-style and European-style

An American or (American style) option

is an option contract that can be exercised at any time between the date of purchase and the expiration date. Most exchange trades options are American style. All stocks options are American style.

A European or (European style) option

is an option contract that can only be exercised on the expiration date. Futures contract (i.e. options on commodities) is generally European style options.

There are two kinds of options: call options and put options

Call option

A call option is an option to buy a stock at a specific price on or before a certain date. When you buy a call option, the price you pay for it is called the option premium which secures your right to buy that certain stock at a specified price called the strike price. If you decide not to use the option to buy the stock, your only cost is the option premium.

Put option

Put options are options to sell a stock at a specified price on or before a certain date. With a put option, you can insure a stock by fixing a selling price. If something happens which causes the stock price to fall, you can exercise your option and sell it at its insured price level. If the price of the stock goes up, then you doesn’t need to use the insurance and the only cost that you pay is the option premium.

Rights and Obligations of the buyer and seller for call and put options are:

Call option buyer

  • Call option buyer pays the premium.
  • They have Rights to exercise and buy the shares if something happens.
  • Option buyers earns profit when option prices rises or increase.
  • In option buying losses are limited and gain is unlimited.

Call option seller

  • Call option seller receives the premium pay by the call buyer.
  • They have obligations to sell shares if exercised.
  • Option seller earns profit when option prices falls or remain the same.
  • In Option selling losses are unlimited and gain is limited.

Put option buyer

  • Put option buyer pays the premium (price of the option) to the put option seller.
  • They have right to exercise and buy the shares if something happens.
  • They earn profit when option price fall down or decreases.
  • In this, put buyer can earn unlimited profit and loss is limited.

Put option seller

  • Put option seller receives the premium (price of the option) pay by put option buyer.
  • They have obligation to buy shares if exercised because something happens .
  • They earns profit when prices of option rise or remains the same.
  • In this, put seller have unlimited losses and can earn limited gain.

Stock option is designed by:

  • Name of associated stock
  • Strike price
  • Expiration date
  • The premium paid for the option, plus broker’s commission.

Different states of options based on its intrinsic value

OTM options:

Out of the money. It has no intrinsic value. Otm option come before the current running level strike and their price is goes up as underlying asset go to further levels.

For example
Current level of Nifty 50 is 23500

  • 23300 OTM Option
  • 23400 OTM Option
  • 23500 ATM Option
  • 23600 ITM Option

ATM options

ATM means In the Money options they have no intrinsic value but have time value and it can change as per market condition. Atm options come to current level of instrument and so you get the value for this option.

For example
Current level of Nifty 50 is 23500

  1. 23300 OTM Option
  2. 23500 ATM Option
  3. 23550 ATM Option
  4. 23600 ITM Option

ITM options

In the Money Option.they have intrinsic value and its price increases as strike moves with current levels to further levels of that. See example below: ITM options come after current running strike of instrument.

For example
Current level of Nifty 50 is 23500

  • 23300 OTM Option
  • 23400 OTM Option
  • 23500 ATM Option
  • 23600 ITM Option
  • 23650 ITM Option

Keywords Meaning

Strike price: is a price to buy a certain stock/contract at a specified price or fix price called strike price.

Option premium: price you pay to buy a call or put option is called premium.

Exercise price: fixed price at which the option holder can buy or sell the underlying asset.

Expiration date: date when option expires or matures.

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