What Are Options?

An option is a contract between two parties to exchange a set of stocks at a future date. Learn more about options here.

A stock option is a financial derivative that allows you to trade a stock at a specific price on a future date. Here, the buyer gets the right, but not the obligation,to carry out the transaction on or before the given date. However, the seller has to sell his holdings if the option is exercised.

A stock option is a financial derivative that allows you to trade a stock at a specific price on a future date.

Let's take an example to understand the concept better. Say, you find an apartment(for Rs 50 lakh) that you would love to own, but do not have the money to buy now.You negotiate with the seller, and he gives you an option to buy this house within3 months. However, he charges an extra Rs 1 lakh for this extension.

Now, even if the price skyrockets to Rs 80 lakh, the seller is obliged to sell this house to you if its what you want, as he had already taken Rs 1 lakh on mutual agreement.In case the price moves down to Rs 30 lakh, you can still buy the house, but you don't have the compulsion to buy it. In the latter case, you will lose the token amount (Rs 1 lakh) that you had initially paid.

Some of the terminologies used in options market are elaborated below.

Expiration is the date on which the contract expires. A stock option can be exercised on or before this date. Usually, most options are valid for one month, and they expire on the last Thursday of each month.

Strike price is the price at which the stock mentioned in the contract will be bought or sold on or before the expiry date.

In a call option, when the stock price moves above the strike price (and vice versa in put option), the option is known to be in the money (ITM). On the other hand, in a call option, when the stock price moves below the strike price(and vice versa in put option), it is known as out of the money (OTM).

Premium is the price of the option contract.


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