An option contract is an agreement between two parties to buy/sell an asset (stock or futures contract as an example) at a fixed price and fixed date in the future. It is called an option because the buyer is not obliged to carry out the transaction. If, over the life of the contract, the asset value decreases, the buyer can simply elect not to exercise his/her right to buy/sell the asset.
There are two types of option contracts - Call options and Put options. A Call option gives the buyer the right to buy the underlying asset, while a Put option gives the buyer the right to sell the underlying asset.Stock options can be exercised any time before the expiry date. (Called "american options") Index options can only be exercised on the expiry date. (Called "European options"). European style options have CE/PE as suffix and American Style options hav CA/PA. At present only options on indices are European Style, and Stock options can be exercised at any time.
Strike Price:
There are 2 types of stock options : Call option and Put option. Put options give the holder the right to sell the asset for a specified price, called the strike price. Call options give the holder the right to purchase the asset for a specified price. When the holder of an option contract uses the rights conferred to him to buy or sell the underlying asset, it is known as to "Exercise" the option.
Premium:
Premium value, or sometimes known as the Extrinsic Value or Time Value, of an option is the part of the price that is determined by factors other than the price of the underlying stock. This is what you are paying the seller of the option for the risk that that person is undertaking for selling you the option contract. This "risk money" you are paying the seller is justified and determined by 4 main factors : Time to expiration, Interest Rates, Volatility and Dividends payable. One would need a pricing model such as the Black-Scholes Model to accurately calculate the premium value of a stock option.
The price of a stock option consists only of it's Premium Value when there is no built in value at the moment you bought it (hence no intrinsic value).
eg If u buy 3900 Nifty Call for current month expiry @ premium of 40 Rs then you have to pay whole amount in cash ie. 4000 Rs(if you buy 1 lot i.e. 100 quantity) + Brokerage + Service Tax etc.Now if market crosses 3900 & moves towards 4000 by end of expiry then your call wil appreciate in value & it wil become something like 80 or 100 Rs.That means you have profit of 100-40 = 60 Rs ie 6000 Rs.Now its upto you whether you wanna sell it or not.On the day of the expiry 6000 Rs will be credited to your account & that contract gets expire. The exactly opposite may happen in above example & you could have loss too.
REMEMBER OPTIONS ARE THE THE RIGHT & NOT OBLIGATIONS.
THIS IS THE MOST IMPORTANT DIFFERENCE BETWEEN FUTURE & OPTIONS.
More on Options:http://www.rediff.com/money/option.htm
No comments:
Post a Comment