WHAT IS OPTION - CS EXECUTIVE SECURITY LAW NOTES



Posted on 22-10-2015        By ADMIN



WHAT IS OPTION - CS EXECUTIVE SECURITY LAW NOTES Options: Options are hedging/investment instruments, which allow the buyer the right but not the obligation to buy/sell the underlying stock/ index. The buyer of the option incurs a charge for this right, which is referred to as the “premium”. The option writer or seller is the other party to such a contract who earns the premium. Call Option - Option to buy the stock at a specific price e.g. Mr. A buys a Nifty Call option with a strike price of 4100 at a premium of Rs.100. Mr. B, the seller of the option earns this premium of Rs.100 taking unlimited risk whereas Mr. A’s risk is limited to the premium amount of Rs.100. If at the expiry date, Nifty is trading at 4350, then Mr. A would exercise his option and earn a net amount of Rs.150. The strike price of the contract is 4100 and at the expiry, the Nifty is at 4350. So he stands gainer by Rs.250 (4350 – 4100). He however has incurred a premium of Rs.100, so his net earnings would be Rs.150 (Rs.250 – Rs.100). Now, had the Nifty fallen to 3950, then Mr.A would be a loser by only Rs.100, which is the premium amount. His Call option would not exercise and Mr.B would be a gainer by Rs.100. Put Option - Option to sell the stock at a specified price e.g. Mr. A buys a Nifty Put option with a strike price of 4100 at a premium of Rs.100. Mr. B, the seller/writer of the option earns this premium of Rs.100 taking unlimited risk whereas Mr. A’s risk is limited to Rs.100. If at the expiry date, Nifty is trading at 3850, then Mr. A would exercise his option and earn a net amount of Rs.150. The strike price of the contract is 4100 and at the expiry, the Nifty is at 3850. So he stands gainer by Rs.250 (4100 - 3850). He however has incurred a premium of Rs.100, so his net earnings would be Rs.150 (Rs.250 – Rs.100). Now, had the Nifty risen to 4250, then Mr.A would be a loser by only Rs.100, which is the premium amount. His Put option would not exercise and Mr.B would be a gainer by Rs.100. Spot Mkt Price – It is the price at which the stock is trading in the cash markets. Strike Price - Specified Price at which the underlying may be purchased or sold when the option is exercised. Expiry Date - Last date for exercising the option by buyer--- Last Thursday of the relevant month on NSE.


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