Derivative contracts, commonly known as Derivatives are tradable instruments which derive its value from an underlying asset or assets such as commodities, equities, equity indices etc. There are a variety of derivative products like swap, forward, futures, options etc. The latter two are widely applied in the equity market allover the world and have already been introduced in the Indian equity market too.
Futures
Futures can be defined as derivative contracts based on an underlying asset or assets and the holder of the contract is entitled to purchase a specified quantity of the asset on a future date at the predetermined price.On the other side,the seller of the contract is under obligation to sell the agreed quanity of the asset in question as per the contract terms such as price,time etc. FuturesIndex Futures
Index Futures are future contracts on which the underlying asset is an index like equity indices like the Sensex or Nifty.For trading convenience,these contracts have been standardised as far as market lot,minimum contract value etc are concerned.
In the Indian Equity market context,two equity index or stock index futures are being traded and they are the index futures on the Sensex(BSE 30) and index futures on S&P CNX Nifty of the National Stock Exchange.Stock Futures on the Nifty started trading on 12,June, 2000 is the first derivative instrument in the Indian equity market which was followed by stock index futures on the Sensex.
Minimum Contract value and Market lot
As mentioned earlier,futures on the Sensex and Nifty are being traded in the standardised form, that is,the market lot,minimum contract value etc are standardised.In the case of Sensex Futures,the market lot is decided as 50 units of the Sensex(one unit refers to the value of the index on the contract day)and it is 200 units as far as Nifty futures are concerned.Trading positions could be taken as multiple of these market lots.
The difference in the market lot as stated above occured because of the stipulation by SEBI that a derivative contract should have a minimum value of Rs.2 lakhs for each.When the two stock futures were introduced,the value of the Sensex was a little over 4000 points and the Nifty was just above 1000.Hence,market lots as seen above were required to maintain a minimum value of Rs.2 lakhs per contract.
Contract Value
Contract value at any point of time is the value of the index at that time period multiplied by the market lot.Hence,the contract value may go up or down at different time intervals in accordance to the movement of the index on which the contract is based.
Maturity Period
In the derivative segment of the Indian equity market,contracts are available with three maturity periods at any point of time namely near month contracts,next month contracts and far month contracts.Contracts expiring during the ongoing month are called near month contracts and the other two refer to contracts having maturity dates during the subsequent months.For example,near month contracts for December are all contracts that mature on or before the last day of December while next month and far month contracts are those with maturity dates in January and February.
Normally,the duration of a contract is from the beginning of a month and expires on the last Thursday of that month.In case the last Thursday is a holiday,the working day prior to that will be treated as the expiry or settlement day.
As the contracts for a month expires on the last date decided as above,contracts for the third subsequent month would have opened automatically on the very next day so as ensure contracts having three maturity periods.For example,contracts for December expires on the last day of that month and March contracts will be opened on the next working day making the number of contracts into three(January,February and March)on maturity basis.
Trading and Settlement
Trading in Futures contracts can be effected on a daily basis and one can enter into the trading scenario as a buyer or seller through the Futures and Option Terminals of approved stock brokers(Geojit Securities has offered trading facilities in all Derivative products through all its branches)Whether to start as a buyer or seller depends on one's perspective about the value of the underlying asset,in our case the Nifty.If we expect that the market would go up within a time frame,futures contracts on Nifty would be bought and vice versa.
After entering into a futures contract,the trader can keep his position open till the day of settlement,normally the last Thursday of that month or the position could be closed out by effecting an opposite transaction(a sell against a buy and vice versa).So long as the position is open(open position refers to outstanding purchase or sales positions at any point of time),the same will mark to market(MTM, that is,revaluation of the asset on a daily basis)everyday at the daily settlement price, that is, the closing value of the index on that day and the difference will be credited or debited to the trader's account.Thus,the position will be brought forward to the next day at the daily settlement price.On the day of settlement(expiry day) all open contracts for that month will be closed out by the Exchange at the settlement price(Settlement price is the closing value of the asset on the day of settlement/maturity day)
Contract value at any point of time is the value of the index at that time period multiplied by the market lot.Hence,the contract value may go up or down at different time intervals in accordance to the movement of the index on which the contract is based.
Maturity Period
In the derivative segment of the Indian equity market,contracts are available with three maturity periods at any point of time namely near month contracts,next month contracts and far month contracts.Contracts expiring during the ongoing month are called near month contracts and the other two refer to contracts having maturity dates during the subsequent months.For example,near month contracts for December are all contracts that mature on or before the last day of December while next month and far month contracts are those with maturity dates in January and February.
Normally,the duration of a contract is from the beginning of a month and expires on the last Thursday of that month.In case the last Thursday is a holiday,the working day prior to that will be treated as the expiry or settlement day.
As the contracts for a month expires on the last date decided as above,contracts for the third subsequent month would have opened automatically on the very next day so as ensure contracts having three maturity periods.For example,contracts for December expires on the last day of that month and March contracts will be opened on the next working day making the number of contracts into three(January,February and March)on maturity basis.
Trading and Settlement
Trading in Futures contracts can be effected on a daily basis and one can enter into the trading scenario as a buyer or seller through the Futures and Option Terminals of approved stock brokers(Geojit Securities has offered trading facilities in all Derivative products through all its branches)Whether to start as a buyer or seller depends on one's perspective about the value of the underlying asset,in our case the Nifty.If we expect that the market would go up within a time frame,futures contracts on Nifty would be bought and vice versa.
After entering into a futures contract,the trader can keep his position open till the day of settlement,normally the last Thursday of that month or the position could be closed out by effecting an opposite transaction(a sell against a buy and vice versa).So long as the position is open(open position refers to outstanding purchase or sales positions at any point of time),the same will mark to market(MTM, that is,revaluation of the asset on a daily basis)everyday at the daily settlement price, that is, the closing value of the index on that day and the difference will be credited or debited to the trader's account.Thus,the position will be brought forward to the next day at the daily settlement price.On the day of settlement(expiry day) all open contracts for that month will be closed out by the Exchange at the settlement price(Settlement price is the closing value of the asset on the day of settlement/maturity day)
Margins
Two types of margins need to be paid to take up and hold positions in the option segment.They are known as Initial margin and Mark to Market Margin.While the initial margin has to be paid upfront as a percentage of the value of the underlying before the deal is struck,mark to market margin emerges daily when the contract is mark to marketed and the same has to be paid on next day basis.Failure to pay margins by clients will result into compulsory close out of one's position as insisted by SEBI.
Two types of margins need to be paid to take up and hold positions in the option segment.They are known as Initial margin and Mark to Market Margin.While the initial margin has to be paid upfront as a percentage of the value of the underlying before the deal is struck,mark to market margin emerges daily when the contract is mark to marketed and the same has to be paid on next day basis.Failure to pay margins by clients will result into compulsory close out of one's position as insisted by SEBI.
Stock Futures
Stock Futures or equity futures can be defined as future contracts in which the underlying asset is an individual share.As mentioned earlier,the holder of such a contract is eligible to purchase a certain quantity of the equity in question on a future date at the mutually agreed price. For the time being,stock futures have been introduced in 31 shares in the Indian equity market.The list is the same as the stocks on which option trading facilities are available.
Speculative Trading and Hedging
Futures are beneficial to operators to make gains through successful trading as well as hedging one's risk in other segments of the market like the equity segment.
Hedging
Hedging is the act of taking a position in the futures market which is exactly the opposite of one's position in other segments of the market such as the equity segment,with a view of offsetting losses in one segment(say,in equities)with a gain in the other(say,futures)
The rationale behind these acts lies on the fact that both segments of the market(Futures and equities) are moving in tandem and hence the loss on buying positions in equities could be eliminated or reduced to the minimum by taking a reverse position in the futures market. To elaborate,let us assume that one has a good equity portfolio of Rs.10 lakhs and he wants to hedge his portfolio against market falls.Simply speaking,he can do so by taking a sales position of Rs.10 lakhs or a little more in the futures segment.
Suppose that the market is falling in due course.It is no doubt that the investor would have lost on his portfolio.On the other side,he would have made a reasonable profit from the futures segment where he is a seller on the simple reason that he can settle the deal by purchasing futures contracts at a price lower than the one on which the sales were effected.Thus,the loss in equities are made up by the gain in futures as the market falls.
Speculative Trading
The main drawback of hedging is that the profit generated from one side is eaten up by the loss on the other and hence,profitability would be the minimum.Therefore,hedging is widely used by large fund managers,high networth individual investors etc and the major objective is to eliminate risk rather than making big gains from trading.Those who are interested in making gains can take positions in Futures contracts on the basis of his expectations regarding the way in which the market would move.
The main drawback of hedging is that the profit generated from one side is eaten up by the loss on the other and hence,profitability would be the minimum.Therefore,hedging is widely used by large fund managers,high networth individual investors etc and the major objective is to eliminate risk rather than making big gains from trading.Those who are interested in making gains can take positions in Futures contracts on the basis of his expectations regarding the way in which the market would move.
Option can be defined as a derivative contract which gives the holder a right, but no obligation,to buy or sell a specified quantity of the underlying asset on a future date at the predetermined price. Accordingly,an option contract consists the following.
Two parties,option buyer and option seller.Option buyer,also known as the option holder enjoys the right to purchase or sell the underlying as per the terms of the contract.However,it is not obligatory from his side that this right has to be executed.In other words,the buyer has absolute freedom to walk away from the contract if he feels that the terms of the contract are not in his favour.
Option Seller,also known as option writer is obligated to buy or sell as per the contract terms provided the buyer comes forward to execute his rights.
Underlying.The agreement is drwan on a specified quantity of an asset or assets and this is known as the underlying.
Strike Price.Both the parties have agreed to transact the business at a particular price and this will be recorded on the contract.This is called the strike price or the exercise price.
Expiry Date.The contract will be valid upto a certain point of time as recorded on the document and this is called the expiry date.
Option Premium
Option premium is the price that has to be paid by the option buyer to the seller to acquire the right to buy or sell.To the buyer,this is the cost of buying options whereas this is the income to the option seller.
Settlement Price
This is the price at which all outstanding positions are cleared by the Exchange on the settlement day(generally,the expiry day)and the price is arrived at on the basis of the spot value of the asset on that day.
Types of Options
broadly, options can be classified into two namely call option and put option.
Call Option
A call option gives the right, but no obligation to the contract buyer to purchase a specified quantity of the underlying asset subject to the contract terms such as strike price, exercise date etc.
On the other side, the seller of a call option is bound to honor the rights of the buyer as per the contract terms.
Limited Risk and Unlimited Profitability to the Buyer
A call option is bought when the contract buyer is bullish (expects that the price would rise) about the underlying asset and expects that a profit could be made by exercising his right (to buy) at the strike price and selling the asset at a higher price which is decided by the spot value of the asset. If things are going as expected, the call buyer can make a handsome profit and this could be termed as unlimited.
On the other side, his loss is limited only up to the premium paid if the value of the asset remained stagnant or even lower.
For example, person A purchases a right to buy 100 shares of Infosys Technologies at a price of Rs.3500(strike price) per share on the last day of December,2001(expiry day) and the right is bought at a premium of Rs.100 per share. Also assume that Infosys share price has increased to Rs.3900 on the expiry day. The call buyer will purchase Infosys at Rs.3500/share (since this is the strike on the contract) from the call seller and the same will be sold at Rs.3900/share because it is the settlement value. His gain after deducting the premium is Rs.300 per share.
Conversely,suppose that value of Infosys has come down to Rs.3000 on the expiry day.He can simply walk away from the contract and what he has to lose is the premium and nothing more.
Limited Profit and Unlimited loss to the Seller
Unlike a call buyer,the writer of a call option is bearish on the underlying asset(expects that the price would fall) and the call is sold on expectation that a profit could be made to the extent of the premium received.So long as he is right, the seller makes a profit but this is limited to the premium.On the other side,the call writer may be a big loser if the value of the asset increases.In such an occasion, he has to buy it from the market at a higher price to fulfill his obligation to sell to the call buyer and this loss may be unlimited.
This is the price at which all outstanding positions are cleared by the Exchange on the settlement day(generally,the expiry day)and the price is arrived at on the basis of the spot value of the asset on that day.
Types of Options
broadly, options can be classified into two namely call option and put option.
Call Option
A call option gives the right, but no obligation to the contract buyer to purchase a specified quantity of the underlying asset subject to the contract terms such as strike price, exercise date etc.
On the other side, the seller of a call option is bound to honor the rights of the buyer as per the contract terms.
Limited Risk and Unlimited Profitability to the Buyer
A call option is bought when the contract buyer is bullish (expects that the price would rise) about the underlying asset and expects that a profit could be made by exercising his right (to buy) at the strike price and selling the asset at a higher price which is decided by the spot value of the asset. If things are going as expected, the call buyer can make a handsome profit and this could be termed as unlimited.
On the other side, his loss is limited only up to the premium paid if the value of the asset remained stagnant or even lower.
For example, person A purchases a right to buy 100 shares of Infosys Technologies at a price of Rs.3500(strike price) per share on the last day of December,2001(expiry day) and the right is bought at a premium of Rs.100 per share. Also assume that Infosys share price has increased to Rs.3900 on the expiry day. The call buyer will purchase Infosys at Rs.3500/share (since this is the strike on the contract) from the call seller and the same will be sold at Rs.3900/share because it is the settlement value. His gain after deducting the premium is Rs.300 per share.
Conversely,suppose that value of Infosys has come down to Rs.3000 on the expiry day.He can simply walk away from the contract and what he has to lose is the premium and nothing more.
Limited Profit and Unlimited loss to the Seller
Unlike a call buyer,the writer of a call option is bearish on the underlying asset(expects that the price would fall) and the call is sold on expectation that a profit could be made to the extent of the premium received.So long as he is right, the seller makes a profit but this is limited to the premium.On the other side,the call writer may be a big loser if the value of the asset increases.In such an occasion, he has to buy it from the market at a higher price to fulfill his obligation to sell to the call buyer and this loss may be unlimited.
Covered Call
If a call is written on an asset on the backing of long position(buying) of the same asset in the cash market,it is known as a covered call.Since,the call seller has bought the required quantity of the asset in the cash market, losses due to a price increase of the asset could be eliminated.
Naked Calls
A naked call is one where the seller of the call option does not have position in the underlying asset.
Put Option
Put Option refers to a type of option contract which gives its buyer a right,but no obligation,to sell a specified quantity of the underlying asset on a future date at the agreed price(strike price)
On the other side,the seller of the contract is obligated to buy the asset from the contract buyer as per the agreed terms.
As stated earlier,the buyer enjoys unlimited profit and limited loss in the case of put option too while the seller has unlimited loss and limited profit.
In the case of put option,the contract buyer is bearish on the asset(expects that the price would fall)and intents to make a profit by selling at a higher price(strike price) and settling the same by purchasing at a lower rate on the settlement day.The extent to which the strike price(that is his selling price) is higher to the settlement price(that is his buying price) is his profit and this can be termed as unlimited.On the other side,the maximum loss that may incur to the contract buyer is limited upto the premium paid in case his expectations proved wrong.
As far as the seller of put option is concerned,his profit is limited to the premium received while the loss may go up to any level,subject to the difference between the strike price(at which he was forced to buy as per contract terms)and the settlement price on which he has to sell or settle the account.
For example,a put option on Infosys is bought at a strike price of Rs.3200 and on payment of a premium of Rs.80 per share.In this case,the contract buyer starts to make profit when the price of Infosys falls to Rs.3120(strike price minus premium) and continues to gain to the extent of the price fall. On the other side,his maximum loss is only upto the premium in case the price of Infosys is going up.
From the above discussion,it is clear that the risk is much higher in option writing(selling) than in option buying.Option buyers also enjoy higher leverage to their funds in the sense that big positions of buying and selling could be maintained by payment of a small premium which is just a fraction of the value of the assets underlying.
If a call is written on an asset on the backing of long position(buying) of the same asset in the cash market,it is known as a covered call.Since,the call seller has bought the required quantity of the asset in the cash market, losses due to a price increase of the asset could be eliminated.
Naked Calls
A naked call is one where the seller of the call option does not have position in the underlying asset.
Put Option
Put Option refers to a type of option contract which gives its buyer a right,but no obligation,to sell a specified quantity of the underlying asset on a future date at the agreed price(strike price)
On the other side,the seller of the contract is obligated to buy the asset from the contract buyer as per the agreed terms.
As stated earlier,the buyer enjoys unlimited profit and limited loss in the case of put option too while the seller has unlimited loss and limited profit.
In the case of put option,the contract buyer is bearish on the asset(expects that the price would fall)and intents to make a profit by selling at a higher price(strike price) and settling the same by purchasing at a lower rate on the settlement day.The extent to which the strike price(that is his selling price) is higher to the settlement price(that is his buying price) is his profit and this can be termed as unlimited.On the other side,the maximum loss that may incur to the contract buyer is limited upto the premium paid in case his expectations proved wrong.
As far as the seller of put option is concerned,his profit is limited to the premium received while the loss may go up to any level,subject to the difference between the strike price(at which he was forced to buy as per contract terms)and the settlement price on which he has to sell or settle the account.
For example,a put option on Infosys is bought at a strike price of Rs.3200 and on payment of a premium of Rs.80 per share.In this case,the contract buyer starts to make profit when the price of Infosys falls to Rs.3120(strike price minus premium) and continues to gain to the extent of the price fall. On the other side,his maximum loss is only upto the premium in case the price of Infosys is going up.
From the above discussion,it is clear that the risk is much higher in option writing(selling) than in option buying.Option buyers also enjoy higher leverage to their funds in the sense that big positions of buying and selling could be maintained by payment of a small premium which is just a fraction of the value of the assets underlying.
Intrinsic Value
The difference between strike price of a contract and the spot value of the underlying asset at any point of time is the intrinsic value.Based on this,option contracts are said to be in the money at the money and out of the money.
In the Money
A contract is in the money when the contract is in favour of the buyer,that is,a profit could be made by trading or exercising his rights.
In fact,it depends on the difference between the strike price and the exercise value and hence will differ in the case of call option and put option.
A call option is in the money when the settlement value of the asset is higher than the strike price.
A put option will be in the money when the settlement value is lower than the strike price.
At the Money
An option contract is said to be in the money when there is no cash flow from exercising the contract.Such a situation arises when the strke price is equal to the exercise price and the case is the same in both call options and put options.
Out of the Money
An option contract is out of the money when the contract is not in favour of the buyer,that is,a profit could not be generated by exercising the right or by trading.
A call option is out of the money at times when the strke price is higher than the spot value of the asset.In such circumstances,a profit could not be made from the contract.
A put option is out of the money when the strike price is lower than the spot value or settlement price of the asset.
When a contract is out of the money,the premium fetched by it may be lower as compared to other times.A contract which may be out of the money at a point of time may turn to be in the money at another time and vice versa.
The difference between strike price of a contract and the spot value of the underlying asset at any point of time is the intrinsic value.Based on this,option contracts are said to be in the money at the money and out of the money.
In the Money
A contract is in the money when the contract is in favour of the buyer,that is,a profit could be made by trading or exercising his rights.
In fact,it depends on the difference between the strike price and the exercise value and hence will differ in the case of call option and put option.
A call option is in the money when the settlement value of the asset is higher than the strike price.
A put option will be in the money when the settlement value is lower than the strike price.
At the Money
An option contract is said to be in the money when there is no cash flow from exercising the contract.Such a situation arises when the strke price is equal to the exercise price and the case is the same in both call options and put options.
Out of the Money
An option contract is out of the money when the contract is not in favour of the buyer,that is,a profit could not be generated by exercising the right or by trading.
A call option is out of the money at times when the strke price is higher than the spot value of the asset.In such circumstances,a profit could not be made from the contract.
A put option is out of the money when the strike price is lower than the spot value or settlement price of the asset.
When a contract is out of the money,the premium fetched by it may be lower as compared to other times.A contract which may be out of the money at a point of time may turn to be in the money at another time and vice versa.
Settlement in option contracts
As stated earlier,each option contract carries an expiry date beyond which,the contract does not have any value and all contracts have to be settled on the settlement date that may be either the expiry date itself or any day prior to that.On the day of settlement,all open positions(buying or selling of calls and put which are not covered by an opposite transaction) which are in the money are compulsorily settled by the Exchange at the settlement price which is the spot value of the asset in question on the settlement day and subsequently,the profit is handed over to buyers.All contracts at the money or out of the money on the settlement day will be allowed to expire as worthless.
American Options
In American Model of options,call or put contracts can be settled on any day that falls between the date of entry and the expiry date.
European Options
In the European Model of options,settlement on all open positions could be undertaken on the final settlement day alone.However,buying positions could be squarred up or selling positions could be covered by opposite transactions on a daily basis.
Assignment
When an option buyer comes forward to execute his right to buy or sell,the obligation to honor this right falls upon a seller and a notice may be served for this purpose.The process of vesting obligation on a seller is called assignment.
Options trading in the Indian Equity Market
Index Options
Options on stock indices commenced on June,4,2001 in the Futures & Option (F&O) segment of the National Stock Exchange and subsequently in the Stock Exchange,Mumbai.
Index Options can be defined as contracts on which the underlying asset is a stock index.These option contracts give us the right to buy or sell equity indices as per the contract terms such as strike price,expiry date etc and the transaction will be settled in cash because index can not be handed over from person to person.
Currently,index options are available on the S&P CNX Nifty of the NSE and on the Sensex(BSE 30)of the Stock Exchange,Mumbai.
Equity Options
Besides index options,equity options or stock options are also commenced on July,2,2001 and option trading is available on 31 individual stocks.The list is the same as those stocks on which Stock Futures are available and it has already been covered.
As stated earlier,each option contract carries an expiry date beyond which,the contract does not have any value and all contracts have to be settled on the settlement date that may be either the expiry date itself or any day prior to that.On the day of settlement,all open positions(buying or selling of calls and put which are not covered by an opposite transaction) which are in the money are compulsorily settled by the Exchange at the settlement price which is the spot value of the asset in question on the settlement day and subsequently,the profit is handed over to buyers.All contracts at the money or out of the money on the settlement day will be allowed to expire as worthless.
American Options
In American Model of options,call or put contracts can be settled on any day that falls between the date of entry and the expiry date.
European Options
In the European Model of options,settlement on all open positions could be undertaken on the final settlement day alone.However,buying positions could be squarred up or selling positions could be covered by opposite transactions on a daily basis.
Assignment
When an option buyer comes forward to execute his right to buy or sell,the obligation to honor this right falls upon a seller and a notice may be served for this purpose.The process of vesting obligation on a seller is called assignment.
Options trading in the Indian Equity Market
Index Options
Options on stock indices commenced on June,4,2001 in the Futures & Option (F&O) segment of the National Stock Exchange and subsequently in the Stock Exchange,Mumbai.
Index Options can be defined as contracts on which the underlying asset is a stock index.These option contracts give us the right to buy or sell equity indices as per the contract terms such as strike price,expiry date etc and the transaction will be settled in cash because index can not be handed over from person to person.
Currently,index options are available on the S&P CNX Nifty of the NSE and on the Sensex(BSE 30)of the Stock Exchange,Mumbai.
Equity Options
Besides index options,equity options or stock options are also commenced on July,2,2001 and option trading is available on 31 individual stocks.The list is the same as those stocks on which Stock Futures are available and it has already been covered.
Salient Features
Market Lot
As seen earlier in Futures,option contracts are standardised products as far as minimum value,market lot,expiry dates etc are concerned.Like Futures contracts,the minimum value per contract has been fixed at Rs.2 lakhs as recommended by SEBI and the market lots are designed so as to maintain the above stated minimum value.Hence,option contracts on Nifty are available in the lots of 200 units and its multiples while the Sensex is being traded in 50 units lots.
As far as stocks options are concerned,market lot differs from scrip to scrip and this is decided so as to ensure the minimum value of Rs.2 lakhs per contract.
Expiry date
At any point of time,three varieties of option contracts are available when looked from the maturity angle, namely the near month,next month and far month contracts and the expiry dates are on the last Thursday of each month(near month refers to contracts that expire in the current and the other two are contracts having expiry dates in the next two subsequent months respectively)For example,in January,all January contracts are near month contracts,Februry and March contracts are next month and far month contracts respectively.
Trading and settlement
Final settlement of option contracts is on the last Thursday of each month and all open positions on the settlement date will be closed out by the Exchange at the settlement price(spot value of the asset on the settlement date) if the contracts are in the money.Option contracts out of the money or at the money will be allowed to expire because they are worthless from the point of view of option buyers.
Besides,final settlement of the contracts by the Exchanges concerned,buying or selling positions of option holders and writers could be traded on a daily basis and positions could be closed out at any time by entering into an opposite transaction.For example, a buying position in a type of contract could be closed out by effecting a sell and vice versa and profit can be booked without waiting for the final settlement day.Thus,options are giving profitable trading opportunities to the partcipants on a daily basis.
Trading Terminologies
One can enter into the option segment as a buyer or seller in any contract type like call or put and can walk away with the profit,if any,at any point of time.The following are some of the major terminologies used by the traders.
Long
One is long in a stock when he is having a purchase position in it.Hence,buying positions in call or put options can be termed as long positions.
Market Lot
As seen earlier in Futures,option contracts are standardised products as far as minimum value,market lot,expiry dates etc are concerned.Like Futures contracts,the minimum value per contract has been fixed at Rs.2 lakhs as recommended by SEBI and the market lots are designed so as to maintain the above stated minimum value.Hence,option contracts on Nifty are available in the lots of 200 units and its multiples while the Sensex is being traded in 50 units lots.
As far as stocks options are concerned,market lot differs from scrip to scrip and this is decided so as to ensure the minimum value of Rs.2 lakhs per contract.
Expiry date
At any point of time,three varieties of option contracts are available when looked from the maturity angle, namely the near month,next month and far month contracts and the expiry dates are on the last Thursday of each month(near month refers to contracts that expire in the current and the other two are contracts having expiry dates in the next two subsequent months respectively)For example,in January,all January contracts are near month contracts,Februry and March contracts are next month and far month contracts respectively.
Trading and settlement
Final settlement of option contracts is on the last Thursday of each month and all open positions on the settlement date will be closed out by the Exchange at the settlement price(spot value of the asset on the settlement date) if the contracts are in the money.Option contracts out of the money or at the money will be allowed to expire because they are worthless from the point of view of option buyers.
Besides,final settlement of the contracts by the Exchanges concerned,buying or selling positions of option holders and writers could be traded on a daily basis and positions could be closed out at any time by entering into an opposite transaction.For example, a buying position in a type of contract could be closed out by effecting a sell and vice versa and profit can be booked without waiting for the final settlement day.Thus,options are giving profitable trading opportunities to the partcipants on a daily basis.
Trading Terminologies
One can enter into the option segment as a buyer or seller in any contract type like call or put and can walk away with the profit,if any,at any point of time.The following are some of the major terminologies used by the traders.
Long
One is long in a stock when he is having a purchase position in it.Hence,buying positions in call or put options can be termed as long positions.
Short
A short position occurs when we have an obligation to deliver(for example,delivery of shares towards our sales).In options too,the term short is used in the same sense and it can be defined as the selling positions in call or put options.
Opening Buy(buy open)
Opening buy refers to the purchase of an option contract which has the effect of creating a fresh purchase position(long) or adding to the existing long position of a trader.Purchase can be effected in either call options or put options.
Opening sell (sell open)
Opening sell means a sale position in either the call or put options and it creates a fresh sell position(short) or adding to one's existing short(sale) position.
Close out
Close out is a buying or selling transaction which closes an open position fully or partly.For example,a purchase position in an option contract can be offsetted by the sale of a contract having the same charecteristics.
Closing Buy(buy close)
Closing buy refers to a purchase transaction which has the effect of closing out a short position(sale position) partly or wholly.For example,a call option seller can close his short position through the purchase of a call option and this is similar to short covering in the equity segment.
In order to cover a short position in call having some special features such as underlying asset,strike price,exercise date etc,one should select a call option having the same charecteristics.Note that a call option cannot be closed out by a put option or vice versa.
Though both the options should fundamentally be the same ,the premium on which they are bought and sold may be different since this is determined by the market forces from time to time.It gives an opportunity to the trader to make gains from buying and selling of option contracts.For example,if the sale of the contract was at a higher premium than the premium for purchase,the trader would have made a profit in the above case.
A short position occurs when we have an obligation to deliver(for example,delivery of shares towards our sales).In options too,the term short is used in the same sense and it can be defined as the selling positions in call or put options.
Opening Buy(buy open)
Opening buy refers to the purchase of an option contract which has the effect of creating a fresh purchase position(long) or adding to the existing long position of a trader.Purchase can be effected in either call options or put options.
Opening sell (sell open)
Opening sell means a sale position in either the call or put options and it creates a fresh sell position(short) or adding to one's existing short(sale) position.
Close out
Close out is a buying or selling transaction which closes an open position fully or partly.For example,a purchase position in an option contract can be offsetted by the sale of a contract having the same charecteristics.
Closing Buy(buy close)
Closing buy refers to a purchase transaction which has the effect of closing out a short position(sale position) partly or wholly.For example,a call option seller can close his short position through the purchase of a call option and this is similar to short covering in the equity segment.
In order to cover a short position in call having some special features such as underlying asset,strike price,exercise date etc,one should select a call option having the same charecteristics.Note that a call option cannot be closed out by a put option or vice versa.
Though both the options should fundamentally be the same ,the premium on which they are bought and sold may be different since this is determined by the market forces from time to time.It gives an opportunity to the trader to make gains from buying and selling of option contracts.For example,if the sale of the contract was at a higher premium than the premium for purchase,the trader would have made a profit in the above case.
Closing Sell(sell close)
Closing sell means a sale transaction which offset a long position either wholly or partly.For example,the buyer of a put or call can eliminate his long position by effecting a sale in the same type of contract and this is similar to squarring up of long positions in the equity market.As stated earlier,a long position in call can be closed out by the sale of a call option only and the basic charecteristics of both the contracts such as underlying asset,strike price,expiry date etc should be perfectly matched to each other.
As stated earlier,the difference in premium ,if any,is the profit/loss of the trader.
Option Class
Option class may be defined as all listed options of a particular type(all call options or all put options) on an underlying asset.For example,all call options on Infosys is one class while all put options are another class.
Option Series
An option series consists of all the listed options contracts of a given class that have the same strike price and expiry date.
Open Interest
Open interest refers to the total number of contracts outstanding on a particular asset at any point of time that are not yet offsetted by counter transactions or settled through delivery or payment of cash.
Time Value
An option contract is priced partly on the basis of the number of days left for its expiry and this is called time value.The premium on an option contract is decided by the intrinsic value and the time value.If more days are left to the expiry date,the premium would be higher due to better time value.
Closing sell means a sale transaction which offset a long position either wholly or partly.For example,the buyer of a put or call can eliminate his long position by effecting a sale in the same type of contract and this is similar to squarring up of long positions in the equity market.As stated earlier,a long position in call can be closed out by the sale of a call option only and the basic charecteristics of both the contracts such as underlying asset,strike price,expiry date etc should be perfectly matched to each other.
As stated earlier,the difference in premium ,if any,is the profit/loss of the trader.
Option Class
Option class may be defined as all listed options of a particular type(all call options or all put options) on an underlying asset.For example,all call options on Infosys is one class while all put options are another class.
Option Series
An option series consists of all the listed options contracts of a given class that have the same strike price and expiry date.
Open Interest
Open interest refers to the total number of contracts outstanding on a particular asset at any point of time that are not yet offsetted by counter transactions or settled through delivery or payment of cash.
Time Value
An option contract is priced partly on the basis of the number of days left for its expiry and this is called time value.The premium on an option contract is decided by the intrinsic value and the time value.If more days are left to the expiry date,the premium would be higher due to better time value.
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