What are Options?
Options are
contracts that give the buyers the right (but not the obligation) to buy or
sell a specified quantity of certain underlying asset at a specified price
on or before a specified date. On the other hand, the seller is under
obligation to perform the contract (buy or sell the underlying). The
underlying asset can be share, index, interest rate, rupee-dollar exchange
rate, commodities etc.
In stock
markets, there are two types of options which are actively traded:
Call Option:
These effectively are
right to buy
a specified quantity of certain underlying asset at a specified price on or
before a specified date
Put Option:
These effectively are
right to sell
a specified quantity of certain underlying asset at a specified price on or
before a specified date
How do call & put options work and what
are the factors that affect the price of an option?
Let’s take example of Punj Lloyd. which trades at Rs. 200 today (one lot of
Punj LLoyd is for 750 shares on nse). Call Options will have various strike
prices. In this case you would have strike price of 160, 170, 180 and
thereafter in multiples of 10. If you are bullish you would buy a call
option for either 200 / 210 / 220 depending on how much premium you are
willing to pay. Let’s assume you buy a call option with strike price of 210
at Rs.10.
You
will make a profit if the price of Punj LLoyd goes above Rs.220 i.e. strike
price + the option premium you have paid. If the price is Rs. 230/- you
would make a profit of Rs.10 per share. The lot size in case of options is
similar to futures. In case the price of the future is below Rs.210, the
maximum loss which an investor could have is Rs.10 (equivalent to the
premium paid on the option)
The put options works in very similar nature but on the reverse side i.e. in
call option you make profit when the stock price increases above ‘strike
price + premium’ on call option while in a put option you make profit when
the stock price goes below ‘strike price – premium’ on put option.
A
call option is bought when an investor is bullish on a stock while a put
option is purchased when an investor is bearish on a stock.
The
factors which affect the price of an option are: Price of the stock, strike
price, time to expiration, risk free interest rate and volatility of the
price of underlying stock.
Benefits of Options v/s Futures :
|
• |
Limits your losses |
|
• |
Unlimited profit potential (although lesser compared
to futures) |
|
• |
Minimal capital requirement. |
