Options
An option is a right, not a duty. It lets you buy or sell something at a price fixed today, without having to, and you pay for that choice up front. This lesson covers how options work; the next shows what each of the four basic positions pays.
The right, not the obligation
A call option gives its buyer the right to buy the underlying at a fixed price. A put option gives its buyer the right to sell it at a fixed price.
The buyer pays the seller for that right. The seller, also called the writer, takes the money and takes on the obligation in return: if the buyer decides to use the option, the seller has to go through with it.
The terms
- Underlying: what the option is on, such as a share or an index.
- Strike price: the fixed price at which the option lets you buy or sell.
- Expiry: the last day the option exists.
- Premium: the price of the option, paid by the buyer to the seller.
- Lot size: exchange-traded options come in fixed lots rather than single units, so the rupee amounts are the figures for one unit multiplied by the lot.
European and American
An American option can be used, or exercised, on any day up to expiry. A European option can only be exercised on the expiry day itself. Many textbooks assume American options, but in India every exchange-traded option on shares and indices is European. You can still sell the option to someone else before expiry; you just cannot exercise it early.
Index options settle in cash: you receive the difference in value, not the index. Options on individual shares settle by actual delivery of the shares when they are exercised.
In, at or out of the money
Whether an option would be worth using right now depends on where the underlying’s price stands against the strike:
| Call: the right to buy | Put: the right to sell | |
|---|---|---|
| In the money | Price above the strike | Price below the strike |
| At the money | Price at the strike | Price at the strike |
| Out of the money | Price below the strike | Price above the strike |
What a premium is made of
An option’s premium has two parts:
- Intrinsic value: what it would be worth if exercised right now. A call with a ₹100 strike, on a share trading at ₹110, has ₹10 of intrinsic value. An option that is out of the money has none.
- Time value: everything above that. It is what a buyer pays for the chance that the option ends up worth more before it expires. It shrinks as expiry approaches, and reaches zero on the day.
Try it
An option with a ₹100 strike on a share that swings about 20% a year
Move the share price and the premium follows the intrinsic value closely when the option is deep in the money, and is almost all time value near the strike. Cut the days to expiry and watch the time value drain away.
A premium also depends on how much the underlying swings (bigger swings make options worth more), on interest rates, and on expected dividends. The options calculator prices an option from all of these with the Black–Scholes model, the same one behind this panel, and shows the Greeks, which measure how the price responds to each.
Work it out on your own numbers
- Options calculatorBlack–Scholes prices, every Greek, implied volatility and a strategy builder.
This lesson explains ideas. It is not advice about what to buy, sell or hold.