Chapter 2: What are Options Contracts?
Options are standardised derivative contracts traded on recognized stock exchanges like NSE and BSE which derive their value from an underlying asset.
There are 2 parties to the contract:
Yes, you heard it right, the buyer of the option has the right and not an obligation to buy or sell the underlying asset. The seller also known as the option writer has the obligation to sell/deliver the underlying asset as per the contractual agreement.
Furthermore, there are two types of options contracts:
- Call Option: The right to buy an underlying asset at a predetermined price on a predetermined date.
- Put Options: The right to sell an underlying asset at a predetermined price on a predetermined date.
We shall discuss this in-depth and understand how these option contract types work in the next Chapter.
Options were created to manage the one thing we all are scared of, which is risk. But today options are used not only to manage risk but also to speculate or to hedge traders and investors against volatility.
Let’s decode the concept of Options by the very definition.
Now that you know what option contracts are, let’s jump to the meaning of option trading.
What is Options Trading?
Options trading is the activity of buying or selling “Options” in the futures and options segment of an exchange.
If traders have a bullish bias towards any underlying asset and therefore are buying a CALL Option which is the Right to Buy.
Similarly, if theres is a bearish view towards an underlying asset and therefore are buying a PUT Option that is the Right to Sell the underlying asset based on that bias, they are trading in options.
Options Trading is a high-risk high-reward domain as it involves leverage. Remember we discussed the significance of leverage in F&O markets? Options contracts are no exceptions and most traders flock to options trading because leverage helps increase ROI and compounds the money faster.
Where are Options Traded?
Option Contracts are Exchange Traded. You can find them on recognized stock exchanges. In India, there are 2 major stock exchanges that see significant volumes of options contracts traded daily:
- The Bombay Stock Exchange (BSE)
- The National Stock Exchange (NSE)
Out of these 2 exchanges, NSE has the highest volumes in terms of Total Turnover in the F&O markets. A boom in Options trading in India was witnessed in early 2000 when the NSE launched Index Derivatives on the popular benchmark Nifty 50 Index.
Since then, a wide variety of product offerings in Indexes and Equity derivatives has increased the popularity and volumes of options trading. The exchange currently provides trading in F&O contracts on 4 major indices and close to 200 stocks.