Sunday, May 1, 2016
What Are Option Contracts?
Option contracts or simply 'options' are derivative contracts that give you the option (a right but not an obligation) to buy/sell a particular security or a 'lot' of securities at a predetermined price.
Options come with an expiry date on/before which they need to be exercised.
Option contracts are standardised products and hence the securities underlying such option contracts are traded in pre-determined lots. For example, one option contract on the Infosys stock currently has a lot size of 250 underlying Infosys shares.
Option contracts give you the right but not the obligation to buy/sell a given lot of securities at a pre-determined price. Hence, they are less riskier than futures contracts.
However, this convenience comes at a price and all option contracts require an upfront payment known as the option premium. This premium is the cost of buying an option contract and is payable whether you exercise your option contract or not.
Note that the premium is payable only by the person buying the option contract.
Types Of Option Contracts.
Options are generally of two types: Call Options and Put Options.
When you buy a Call Options, it give you the right but not the obligation to buy a pre-determined lot of securities at a pre-determined price on/before the contract expiry date.
Similarly, when you buy a Put Options, it give you the right but not the obligation to sell a pre-determined lot of securities at a pre-determined price on/before the contract expiry date.
Who is an Option Writer?
Note that when you are buying an option contract (call or put) someone is selling that to you. This person is the option writer and is the one who gets to keep the 'option premium' collected from you.
Now if you are wondering whether you can sell an option contract, the answer is yes. You can write a put or a call option and pocket the premium paid by the buyer.