January 20, 2026
8 mins read
Option contracts give the holder the right to buy or sell an underlying asset at a price decided earlier, and this right can be exercised only within the contract’s stated period. These contracts generally appear as calls, linked to buying, and puts, linked to selling. They are used in different market situations, depending on how participants manage their exposure. The value of an option shifts with movements in the underlying asset, the time left before expiry, and changes in volatility.
When we talk about Options in finance, we are referring to a special type of contract. To put it simply, what are Options? They are financial agreements that give the buyer the right, but not the obligation, to buy or sell something (called the underlying asset) at a fixed price on or before a certain future date.
The underlying asset could be a company’s share, a currency, an index, a commodity such as oil or gold, or another type of security. The value of an Option always depends on the value of the underlying asset, which is why it is called a derivative.
An Option always has three key details: the strike price, the expiry date, and the premium.
The strike price is the agreed price at which the underlying asset can be bought or sold.
The expiry date is the final date by which the Option can be used.
The premium is the cost paid by the buyer for the right.
If the market moves in favour of the buyer, the Option gains value and can either be sold to another trader or exercised to gain a profit. If the market does not move as expected, the buyer can simply let the contract expire, losing only the premium paid.
This flexibility makes Options attractive, as they provide a choice without binding the investor to act if the outcome is not beneficial.
Here are the main characteristics of an Option contract:
Derivative Nature: The value of an Option depends on the performance of the underlying asset.
Expiry Date: Every Option has a set date when it expires. After this, the contract becomes invalid.
Strike Price: This is the price fixed in advance at which the asset can be bought or sold.
Speculative Tool: Traders use Options to speculate on future price movements with lower upfront costs than buying shares directly.
Hedging Tool: Investors use Options to protect themselves from potential losses in other investments.
No Obligation: The buyer has the right to exercise the Option but is not forced to do so.
Settlement: The Option is settled when the buyer decides to use their right to buy or sell.
Contract Size: Each Option comes with a lot size, meaning a fixed number of shares or units of the asset covered by the contract.
There are two main categories of Options:
A call option gives the option holder the right, but not the obligation, to purchase the underlying asset at the strike price prior to the option expiration date. Generally, traders purchase call options when they expect the price of an asset to increase.
A put option gives the option holder the right, but not the obligation, to sell the underlying asset at the strike price prior to the expiration date. Generally, traders use put options when they expect the price of an asset to decrease.
Both call and put options give investors flexibility given their view of the market.
The price of an Option, also known as the premium, is determined by two main components:
Intrinsic Value: This is the real, immediate value of the Option. For a call option, it is the difference between the current market price and the strike price if the market price is higher. For a put option, it is the difference if the market price is lower than the strike price. If there is no difference, the intrinsic value is zero.
Extrinsic Value (Time Value): This is the additional value that comes from the time left until the Option expires, as well as market conditions such as volatility and interest rates. The longer the time to expiry or the greater the market volatility, the higher the premium.
Traders use models such as Black-Scholes to calculate fair prices, but in practice, market demand and supply also affect the premium.
To trade Options effectively, it is important to know some common terms:
At-the-Money (ATM): When the strike price is the same as the market price of the asset.
In-the-Money (ITM): When an Option has real value. For calls, the strike price is lower than the market price. For puts, the strike price is higher than the market price.
Out-of-the-Money (OTM): When an Option has no real value. For calls, the strike price is higher than the market price. For puts, it is lower.
Premium: The cost paid to buy the Option.
Strike Price: The fixed price at which the asset can be bought or sold.
Underlying Asset: The stock, index, currency, or commodity linked to the Option.
Implied Volatility (IV): A measure of how much the market expects the asset’s price to move in the future.
Exercise: Using the right to buy or sell the asset through the Option.
Expiration: The date when the Option contract ends.
Knowing these terms helps investors understand how Options work in the market.
Like all financial tools, Options have their benefits and drawbacks.
Lower Investment Cost: Investors can take positions in the market without needing large amounts of money.
Flexibility: The buyer can choose whether or not to exercise the Option.
Risk Management: Options can be used to protect existing investments from unfavourable price movements.
Profit Potential: Investors can benefit from both rising and falling markets, depending on the type of Option used.
Complexity: Options are not as simple as buying shares, and beginners may find them difficult to understand.
Limited Life: Options expire after a certain date, which means they can lose all value quickly.
Loss of Premium: If the market does not move in the expected direction, the premium paid is lost.
Market Risk: Options are affected by market volatility, which makes them riskier than some other investment types.
Additional Read: What Are Futures and Options?
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Hedging in option trading refers to strategies investors use to minimize potential losses in their investments by taking an opposing position in the options market. For example, if an investor owns a stock that is part of the National Stock Exchange index, they could buy put options to guard against a possible drop in the stock's value.
Options are contracts that provide investors with the choice, but not the requirement, to purchase or sell a specific asset at a set price before the expiration date. This flexibility allows traders to speculate on market movements without having to own the underlying asset outright.
The key benefits of using options include flexibility, leverage, and the ability to hedge against risks. Options can enhance a portfolio's returns without significant capital outlay, allowing investors to participate in market movements while managing their exposure effectively.
The primary drawbacks of options include their complexity and the potential for significant losses. Options can expire worthless if the market does not move in the anticipated direction, leading to a total loss of the premium paid. Additionally, the strategies surrounding options can be intricate, requiring a solid understanding of market dynamics.
Options and futures are both derivatives but differ in their obligations. Options give the buyer the right to buy or sell an asset, while futures contracts obligate both parties to buy or sell the underlying asset at a future date. This fundamental difference impacts the risk and strategy involved in trading each instrument.
An option contract is a financial instrument that gives the holder the choice, without the obligation, to purchase or sell a specific asset at a set price within a certain period. These contracts can be classified into calls and puts, each serving different investment strategies.
Yes, options contracts are considered financial assets. They derive their value from the underlying asset and can be traded in various markets. As a part of an investor's portfolio, options can contribute to both risk management and speculative strategies.
The iron butterfly strategy is a market-neutral options approach that seeks to benefit from limited volatility in the underlying asset. It consists of selling both an at-the-money call and put option, while also purchasing out-of-the-money call and put options. This strategy is particularly effective when the trader anticipates minimal price movement.
Options in trading are contracts that allow investors to purchase or sell a specific asset at a predetermined price. They provide traders with various strategies to leverage their positions, hedge against risks, and enhance their potential returns.
Yes, options are classified as derivatives because their value is derived from the performance of an underlying asset. This characteristic makes options a flexible tool for traders looking to speculate on price movements or hedge against potential losses.
An example of an options trade would be purchasing a call option for a stock listed on the National Stock Exchange index. Suppose the stock is currently priced at ₹1,000, and an investor buys a call option with a strike price of ₹1,050, anticipating that the stock will rise above this level before the expiration date. If the stock price exceeds ₹1,050, the investor can exercise the option to purchase the stock at a lower price, realizing a profit.
Option derivatives are financial contracts that give the buyer the right, but not the obligation, to buy or sell an asset at a set price before a specific date. For example, a call option on a stock allows purchase at a predetermined price, regardless of current market value.
The key difference lies in obligation. In futures, both buyer and seller are obligated to execute the contract on expiry. In options, the buyer has a choice, not an obligation, to exercise the contract. Futures carry more risk, while options offer flexibility with limited loss potential.
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