All about Futures & Options: Part 2

Here’s All you need to know about Futures & Options in Part-2 of the series:

All about Futures & Options: Part 2Options Contracts have been ruling the Indian Derivatives Markets since 2001. These offer broad-based investment opportunity as these are available with a broad range of underlying assets. These are regarded powerful risk management tools owing to their versatility. You can easily adjust your position as per the market dynamics.

Investors speak a lot about options. Hedgers try to eliminate their risk. Speculators take on the risk actively. Arbitrageurs follow the risk-free path. Others strive to do likewise. Those who master the technique mint money. While rest of them exit with burnt fingers.

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Options are seemingly a prudent way towards efficient price discovery and portfolio diversification. However, you also need to explore the other end of the domain. Investing in Options involves substantial risks. These are not friendly vehicles for you if you are a poor driver. You may lose a lot of money in them.

But just ignoring them for lack of knowledge is no solution.

It’s time to gather your courage.

Let’s embark on an insightful journey of Options.

Good enough to brighten your financial lamps!

Options – A Precursor

An Options contract is an agreement between an Option holder (buyer) and the Option Writer (seller). It gives the holder a right, but not an obligation, to buy/sell the underlying asset at a predetermined price. The right needs to be exercised on or before the expiration date. In consideration, the holder pays a premium to the writer. The underlying asset can be equity shares, an index, currency or a futures contract.

If the holder exercises his right, then the writer is obligated to execute the contract. The right may be in the form of a Call or a Put.

A Call Option gives the holder a right to buy the underlying asset at an agreed price before the expiry of the contract. If the holder exercises his right, then the writer has to sell the underlying asset at the contracted price.

Conversely, a Put Option authorises the holder to sell the underlying at the contracted price before the contract expires. Once the put option is exercised, the writer needs to buy the underlying at the said price.

In a way, both the holder and the writer try to predict the price movement of the market. Usually, in Call Option, you as the holder would assume a long position. On the other hand, the option writer would take on a short position. It means that you expect the prices of the underlying to rise and insure your position for a premium. The other party believes the asset price to fall.

In the case of Put Option, the scenario is entirely opposite. The holder goes short while the writer goes long. You as the holder anticipate a fall in asset price while the counterparty presumes a price rise.

Nevertheless, both of you can’t be simultaneously right. There’s never a win-win situation. You would gain at the expense of your counter-party and vice-versa.

It leads us to the critical terms prevalent in the Options domain.

Terminologies used in Options Contract

By now you may be curious to get a hands-on experience. But wait!

Have a look at these terms to enrich your vocab.

Strike Price/Exercise Price

It is the agreed price at which the holder may buy/sell the asset upon exercising his rights on or before contract expiry.

Spot Price

It is the current market price of the asset prevailing when the holder intends to exercise the option to buy/sell the asset. It can be greater than, equal to or less than the Strike Price. Accordingly, the holder decides whether or not to exercise his rights.

Payoff/Intrinsic Value

It is the difference between the Strike Price and the Spot Price. The higher the price differential, the greater would be the profit/loss to the holder.

Expiration Date

It is the date on which the option contract expires. The holder gets the option to exercise his right only till the Expiration date. If he chooses to sit tight, then the Option expires worthless.

Exercise Date

It is the date on which the option is exercised by the holder. The Exercise date varies for European Options and American Option.

In the case of European Options, the holder cannot exercise his right before the expiry date. He may buy/sell the option only at the expiry date. Hence, expiration date and exercise date falls on the same day.

However, in the case of American Options, the holder may exercise his right anytime between the purchase of the contract and its expiration date. Hence, the exercise date may be same as the expiration date or different.

In India, options on “S&P BSE SENSEX” are European style, whereas options on the individual stocks are American style.


Premium is the price that the option holder pays to the writer to acquire the right to buy/sell. You may view it as the cost involved in the purchase of Options Contract.

The premium of an Options Contract depends on a lot many intrinsic and extrinsic factors.

Premium = Intrinsic Value + Time Value

Intrinsic factor is the underlying stock price and determines how much valuable is the stock/asset. Usually, in-the-money options are considered more valuable and thus entail higher premium.

Extrinsic factors are the external factors enable premium determination. These can be the time to expiry, volatility and the interest rates. The nearer the time to expiration, the lesser the value of an Option. The lower would be the premium charged thereof. Highly volatile assets are considered risky causing higher loss to the writer. So, the writer usually charges a higher premium for such Options. An increase in the interest rates increases the value of call option and lowers the value of put option. Hence, the premium would be levied accordingly.

Also read: 9 points you should know before investing in Stock Markets

Moneyness in an Options Contract

Moneyness refers to the worth of the option. It is determined differently for Calls and Puts. An Option can be in-the-money, at-the-money or out-of-money. The holder exercises the right only when the option is in-the-money.

All about Futures & Options: Part 2

Suppose you purchase a European Call option on Stock x at a Strike Price of Rs 4000. For this, you paid a premium of Rs 400. You will exercise your option only when the option is in-the-money. It means when the Spot Price is more than Rs 4400 (Strike Price + Premium). Assume that the price of the stock rises to Rs 4500 and you take the call. Thus, you earned a profit of Rs 100 {(Spot Price – Strike Price) – Premium}.

Conversely, assume that the price of the stock falls to Rs 3990. In this case, you won’t exercise your option. Hence, you lose your premium of Rs 100.

Now let’s take the case of Put Option.

You purchased a European Put Option on a Stock at a Strike Price of Rs 2500. For this, you paid a premium of Rs 200. Assume that the price of the stock falls to Rs 2200 and option becomes in-the-money. Now, you may exercise the option. The profit thus earned would be Rs 100 {(Strike Price – Spot Price)-Premium}.

Risk inherent in Options Contract

Options Contracts aren’t as safe as you think. These too involve risks both from the side of the holder and the writer. You may also regard them as downside risk.

The losses of an option holder are limited to the amount of premium. However, in the case of the writer, his losses may go to any extent.

Uncovered calls may put the writer in a mess. It means that the writer doesn’t own the underlying asset against which he wrote the option. In case the holder exercises his right, the writer gets into trouble. He would have to purchase the stocks well above the exercise price. His loss would be the excess of purchase price paid over exercise price reduced by the amount of premium received.

Put Options, too, come up with their share of risks. If the holder exercises his rights in a falling market, the writer need to purchase shares at the exercise price. The losses would be severe when the spot price of the asset nearly becomes zero.

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Final Words

Options are good to hedge risks in your portfolio. Don’t be lured by cheap call options which could never meet your expectations. Moreover, consider only liquid stocks while buying options. Finally, options writing is a very specialised job. If you want to write options, go for covered calls. Remember to hedge your positions and hold sufficient risk capital to absorb losses. is an award winning personal finance platform. It helps you aggregate all your personal finance accounts like FD, Equity, Mutual Funds, PPF EPF, NPS including, Credit Cards & Loans etc. It's one place where you can track, plan and invest seamlessly. empowers you to invest in zero commission direct plans of mutual funds thereby helping you generate higher on investments. The best part is it comes with a lifetime Free plan.

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