Options

option is purchasing right but not the obligation, to buy or sell a specified underlying item at an agreed upon price, known as exercise price or strike price. In other words Options are contracts that give the buyers the right (but not the obligation) to buy or sell a specified quantity of certain underlying assets 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 asset can be a share, index, interest rate, bond, rupee-dollar exchange rate, sugar, crude oil, Soya bean, cotton, coffee etc. An option contract is a unilateral agreement in which one party, the option writer, is obligated to perform under the contract if the option holder exercises his or her option. (The option holder pays a fee or "premium" to the writer for this option.) The option holder, however, is not under any obligation and will require performance only when the exercise price is favorable relative to current market prices. If, on the one hand, prices move unfavorably to the option holder, the holder loses only the premium. If, on the other hand, prices move favorably for the option holder, the holder has theoretically unlimited gain at the expense of the option writer. In an option contract the exercise price (strike price), delivery date (maturity date or expiry), and quantity and quality of the commodity are fixed. There are two basic types of options-call and put. A call option gives an investor right to buy underlying item during specified period of time at an agreed upon price while put option confers the right to sell it. Before going into Call and Put Options it is necessary to understand • American options can be exercised at any time between the date of purchase and the expiration date. Most exchange-traded options are of this type. . • European options are different from American options in that they can only be exercised at the end of their lives. The options on the Nifty and Sensex are European style options--meaning that the buyer of these options can exercise his options only on the expiry day. He cannot exercise them before the expiry of the contracts as in case with options on stocks. As such the buyer of index options needs to square up his positions to get out of the market. In India all stock options are American style options and index options are European style options. The significant difference between a future and an option is that the option provides the contracting parties only an option, not an obligation, to buy or sell a financial instrument or security at a pre-fixed price, called the strike price. Obviously, the option buyer will exercise the option only when he is in the money, that is, he gains by exercising the option