In the preceding chapter, we got familiar with the primary call option setup. The purpose was to understand a few core ‘Call Option’ ideas such as –
In the upcoming Call Option chapter, we will explore the call option in more depth. Before delving further into the topic, let’s decode a few basic terms associated with options. Explaining these jargons at this point in time will not just reinforce our understanding but also simplify our future discussion of this concept.
Let us now consider the following terms –
Remember, we have only gone over the fundamentals of a call option. I suggest you only research these terms as they relate to that type of option.
The strike price serves as a reference point agreed upon by buyers and sellers when they engage in an options agreement.
Let’s take an example:
By acquiring a XYZ Limited Call Option at Rs.250, the purchaser pays a premium today to obtain the right to potentially purchase the company’s stock at Rs.250 upon expiration. This will only happen if XYZ Limited is trading above this strike price at the end of the specified period. Here is a screenshot from the stock exchange’s website showing the option chain for XYZ Limited, displaying the different strike prices and their associated premiums.
The tabular representation provided above is commonly referred to as an “Option Chain,” which provides information about various strike prices and their corresponding premiums. For now, let’s focus on the highlighted data and ignore other details such as open interest, volume, bid-ask quantity, etc.
We understand that the value of a derivative contract is derived from an underlying asset. The spot market price of the underlying asset is referred to as the underlying price. In the case of XYZ Limited, as mentioned earlier, it is noted at Rs.230/-. This underlying price forms the basis of the call option, and a rise in the underlying price benefits the buyer of the call option.
Exercising an option contract refers to the act of utilising the right to buy the underlying asset upon the expiration of the contract. In the case of a call option, exercising involves the individual exercising their right to purchase the stock at the predetermined strike price.
However, this can only be done if the current trading price of the stock is higher than the strike price. It is crucial to understand that exercising is only possible on the expiration day and not before.
Therefore, if someone purchases an XYZ Limited 240 Call option when the underlying asset is valued at Rs.230 in the spot market, and the price increases to Rs.250 the following day, they cannot execute the settlement against their option on that same day. The settlement will only take place at expiration, based on the spot market price at that time.
Both options and futures contracts have expiration dates. Generally, they fall on the last Thursday of each month. Similar to futures contracts, options contracts are divided into different categories such as current month, mid-month, and far month.
This provides an overview of an option to buy ABC Corporation Ltd at a strike price of Rs.80, priced at Rs.4.50/-. There are three expiration options – current month, mid-month, and far month – with dates of 26th March 2023, 30th April 2023, and 28th May 2023, respectively. It may come as a surprise, but premiums can vary depending on the expiration date. However, it is essential to remember that all contracts have three expiration options, and premiums can differ among them.
Options contracts, like futures contracts, have expiration dates. Typically, they fall on the last Thursday of each month. Like futures, options contracts are categorised into current month, mid-month, and far month.
This is a snapshot of an option to buy PQR Corporation Ltd at a strike price of Rs.90 for a premium of Rs.3.70/-. You can observe three expiration options – 26th March 2023 (current month), 30th April 2023 (mid-month), and 28th May 2023 (far month). Note that premiums may vary among different expirations, but don’t worry too much about this now as we can discuss it in more detail later. The main point to remember is that, like futures, there are three expiration options, and premiums can differ among them.