Brief Guide To Understand Everything Related To Options Trading

What is option?

Option is an agreement that gives a buyer the right (not obligation) to trade an underlying asset (index or stock), at definite price on/before a certain date. In other words, option is similar to bond or stock, which includes a binding agreement with strictly clear terms and conditions.

Option is financial derivatives, whose price is based on underlying stock or index. Options trading newsletter is recommended for new and experienced traders because it helps them to stay updated and grab opportunities.

How are options different than stocks?

Options and stocks are traded actively in the listed market. The differences include –

  • Options are derivatives, whose value is derived from the underlying stock price
  • Options have a specific expiry date, where as stocks don’t
  • Stock owners have their share in the underlying company, so they hold rights to dividend and voting, but options state no such rights.

Let’s understand what is ‘Call’ and ‘Put’

People find options in basically everything but in trading environment listed options are very clearly defined.

Two kinds of options

Call option

You can buy stock at specific price on/before a definite date. It acts like security deposit. (The specific price is the strike price. The price paid is optimum premiums)

Call options increase in price as cost of underlying instrument rises up. If you don’t use call option to purchase stock because you are not obligated, then the only expense occurred is option premium.

Put option

You sell the stock at strike price on or prior specific date. Put options are similar to insurance policies. Put options value increases as underlying instrument’s value decreases.

If stock value falls then you can sell it at insured price level. If stock price increases and you don’t get a chance to use the Put then you just lose the premium cost paid.

Expiration types

European style option – In this style, traders need to hold the option till expiration, after purchase. For example, Index options

American style option – In this style, traders can take action any time, after purchase. For example, Stock options

Jargons used in trade options

Option premium – It is the price paid for the option in the start.

Strike price – It is the cost at which underlying asset is sold or bought as defined in option contract.

In-the-money (ITM)

  • Call – value is higher than strike price
  • Put – cost is lower than strike price

Out-of-money (OTM)

  • Call – Price is lower than strike price
  • Put – Price is higher than strike price

At-the-money (ATM)

Price of underlying asset is equal to strike price

Expiration date – It is the day, when option becomes invalid or ceases to exist. In the US listed stock options expire on the month’s third Friday and if it is a holiday then it falls on Thursday.

Call exercise – Call option holders get a right to buy stock at strike price from call seller.

Put exercise – Put option holders can sell stock at strike price to put seller.

Underlying instrument – It is a commodity or stock or any kind of financial product, whose cost determines the derivative product value. For example, if you hold stock option then you have the right to sell or buy that stock in accordance to terms of that option, which is the underlying instrument.