Options Contract – Meaning & Characteristics

1. Introduction

The most flexible derivative is the Option. Unlike Forwards or Futures where you must fulfill the contract, in Options, you have a choice. It is just like insurance – you pay a premium to get protection, but you are not forced to use it.

2. Definition

"An Option is a contract that gives the holder the RIGHT (but not the obligation) to buy or sell an underlying asset at a specified price (Strike Price) on or before a specified date."

• Key Phrase: "Right but not obligation". This is the heart of options.

3. Types of Options

A. Call Option (Right to Buy)

• Definition: Gives the holder the right to buy the asset.
• View: Bullish. (You profit if market goes up).
• Example: You buy a Reliance 2500 Call Option. If Reliance goes to 3000, you have the right to buy at 2500. Profitable!

B. Put Option (Right to Sell)

• Definition: Gives the holder the right to sell the asset.
• View: Bearish. (You profit if market goes down).
• Example: You buy a Nifty 18000 Put Option. If Nifty falls to 17000, you have the right to sell at 18000. Profitable!

4. Key Terminology

1. Strike Price (Exercise Price): The fixed price at which the deal will happen (e.g., 2500).
2. Premium: The price paid to buy the option (the non-refundable cost).
3. Expiration Date: The last date to use the right.
4. American vs European:
   • American: Can be exercised any time before expiry.
   • European: Can be exercised only on expiry date. (India uses European style for Indices).

5. Exam Notes: Writing the Answer

Question: "Define Options. Distinguish between Call and Put Options." (10 Marks)

Answering Structure:

1. Definition: Focus on "Right but not Obligation".
2. Types: Create a small table comparing Call (Buy) and Put (Sell).
3. Styles: Briefly mention American vs European options.
4. Conclusion: "Options are instruments of non-linear payoff, unlike Futures."

6. Quiz Time! 🎯

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