Options Trading - Indian Economy
Introduction
Contracts known as options grant the holder the right, but not the obligation, to buy or sell a predetermined amount of the underlying asset at a predetermined price at any time up until the contract's expiration date. Options can be bought via brokerage accounts, just like the majority of other asset types. We shall examine the definition, types, and advantages of options in this article.
What Is Options Trading?
• An option is a contract that is linked to an underlying asset, such as a stock or another security. Options contracts have a set expiration date, which may be as short as one day or as long as a few years.
• You have the choice but not the duty to trade the underlying asset once you purchase an option. If you choose to do so, it's known as exercising your right to choose.
• Like futures contracts, options contracts lower the risk for buyers by stipulating a defined future price for an underlying asset. But unlike futures contracts, options contracts do so without requiring a purchase commitment.
• The person who sells an options contract is known as a "options writer." If the buyer decides to execute the options contract on or before the agreed date in return for a down payment, the seller, unlike the buyer, has no rights and is required to sell the assets at the agreed price.
• No physical documents are exchanged at the time an options contract is signed. Simply said, the transactions are transmitted to the stock market, where they are registered. There are various options.
• There are two primary types of options: calls and puts.
An Option To Call Is What?
• Consider a call option as calling the underlying security to you; it gives you the opportunity to buy underlying securities at a given price and within a certain time frame. The sum you pay is known as the striking price. The deadline for exercising a call option is the expiration date.
• Call options come in two types: American and European. American-style options allow you to purchase the underlying asset at any time up until the expiration date. With European-style options, you can only acquire the asset on the expiration date.
• For example, Assume a trader buys 100 shares of RBC stock, one call option contract with a strike price of Rs. 100. He pays Rs. 10 for the option. On the day the option expires, RBC stock shares are trading at Rs. 110 each. The buyer/holder of the option exercises his right to purchase 100 shares of ABC at the option's strike price of Rs. 100 apiece. He immediately sells the stock for the going rate of Rs. 110 per share.
• The table below displays the possible payout for a call option on RBC stock with a Rs. 10 option premium and a Rs. 100 strike price. The buyer loses Rs. 10 if the price of RBC's stock does not increase by more than Rs. On the other side, the call writer makes money so long as the stock price stays below Rs. 100.
A Put Option: What Is It?
• A put option is what a call option is not. A put option gives you the right to sell the underlying asset at a specific strike price rather than the right to buy it (think of it as taking the underlying security away from you).
• Put options also have expiration dates. The same style guidelines (i.e., American or European) apply when you can use them.
• For instance, an investor pays the writer a premium of Rs. 10 to purchase a put option on RBC stock for Rs. 90. Before the expiration date, he may sell the stock to the writer at any time for the strike price of Rs. 90. The put option can be used by the investor to limit losses if he anticipates that the price of RBC stock will drop below Rs. 90 in the upcoming days.
• Figure displays the payout for a fictitious RBC put option with a Rs. 10 option premium and a Rs. 90 strike price. If the stock price doesn't fall and the buyer doesn't exercise his put option, his maximum loss is equal to the cost of the put option contract (Rs. 10).
Options - Advantages
• Futures are inferior trading and hedging instruments to options.
• Costs are lower and the buyer's losses are constrained. The buyer is less impacted by the fluctuation in market prices.
• The addition of options will boost overall market activity while also enhancing the present futures.
• It increases the effectiveness of the commodities market.
• Market players may benefit from futures price discovery when using futures and options together.
Futures Vs Options
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Basis For Comparison |
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Futures |
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Options |
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Meaning |
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A futures contract is a legally binding agreement that allows you to purchase and sell a financial asset at a predetermined price on a future date. |
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Options are contracts in which the investor is given the right but not the obligation to purchase or sell a financial instrument at a predetermined price on or before a specific date. |
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Obligation of buyer |
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Yes, in order to execute the contract. |
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No, you are not obligated to do so. |
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Execution of contract |
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On-time, as agreed. |
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Before the agreed-upon date expires, at any moment. |
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Risk |
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High |
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Limited |
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Advance payment |
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There is no need to pay in advance. |
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Premiums are the method of payment. |
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Degree of profit/loss |
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Unlimited |
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Unlimited profit and limited loss. |
Conclusion
Options are utilized for income generation, speculating, and risk management. Options are classified as derivatives since they derive their value from an underlying asset. Options on any underlying asset, including bonds, currencies, and commodities, can be negotiated. A stock option contract typically represents 100 shares of the underlying stock.