Options are generally classified into two types, the call and put options. The ‘Call Option’ gives the holder of the option the adequate right to buy a particular asset at the strike price on or before the expiration date. In return, an upfront premium is paid to the seller. Call options are usually more valuable as the value of the underlying asset increases. The Put Option gives the holder the right to sell any particular asset at the strike price anytime on or before the pre-set expiration date. In return, an upfront premium is paid to the seller.
Since one can sell a stock at any given point in time it leads to the following two scenarios:
- If the spot price of a stock falls during the contract period, the holder is protected from this fall in price by the pre-set strike price. This is why put options are more valuable when the price of the underlying stock falls.
- If the price of the stock rises during the contract period, the seller only loses the premium amount and does not suffer a loss of the full price of the asset.
USES OF CALL AND PUT OPTIONS
Call Options and Put Options are completely different. They cannot be considered as different sides of the same coin because they are two different coins altogether.
- Call Option helps to maximize profits. The rule is simple, one buys at lows, and sells at highs. A Call Option helps to fix the buying price.
- Put Option is mainly used to fix the selling price of the asset. Put Options are often used when market conditions are bearish. They can protect against the decline of the price of a stock below a specified price.
HOW ARE OPTIONS CONTRACTS PRICED?
Options are bought for an underlying asset at a fraction of the actual price of the asset in the spot market. It is bought by paying an upfront premium. The amount paid as a premium to the seller in the market is the price of entering an options contract.
Let’s take a look at the possible trading scenarios encountered while trading in options:
- In-the-money:One can easily profit by exercising this option.
- Out-of-the-money:One will not be able to make any money by exercising this option.
- At-the-money:A no-profit, no-loss scenario is created if someone chooses to exercise the option.
A Call Option is considered ‘In-the-money’ when the spot price of the asset is higher than the strike price.
Subsequently, a Put Option is ‘In-the-money’ when the spot price of the asset is lower than the strike price.
HOW IS PREMIUM PRICING ARRIVED AT :
Two main factors control the price of an Option Premium:
Intrinsic Value of an Option:
The intrinsic Value of an option is the difference between the cash market spot price and the strike price.
Time Valueof an Option
The time value of an option puts a premium on the time left to exercise an options contract.
One can easily trade with the 5-paisa app. To trade in Futures and Options (call and put option) with 5paisa, one just needs to activate Futures and Options by submitting their required documents like income proofs and have a happy time trading.