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When you first start investing, you find that there are many concepts you must be familiar with to minimise losses and make sure you generate profit.
An options contract is one such crucial instrument you will come across while searching for investing alternatives that have the potential to provide substantial returns. This two-party financial agreement frequently relies on the worth of an underlying asset, such as stocks or securities.
Option contracts can be categorised into two segments: call and put options. In today’s article, we will dive deep into the basics of call options, how they work, and a brief overview of put options. Let’s begin.
Understanding call option and put option
Call and put options are typical derivatives contracts that give buyers certain rights. It does not, however, obligate you to purchase or sell the underlying asset by a certain date or for a predetermined amount. .
Call-and-put options are divided into two categories: European-style options and American-style options. The latter can only be exercised on the day of expiration, while one may do the former before expiration.
Call option
A call option grants the buyer the right to invest in the underlying asset at a pre-agreed price. As the call options contract does not mandate you to proceed with the purchase, you are under no obligation to execute the options contract until it is favourable to you.
A significant component of options is the strike price. It refers to the predefined value of the underlying asset. The call option will result in losses for you unless your strike price is lower than the underlying asset’s market price on the execution date.
If you buy and sell call options on a single underlying asset with different strike prices or expiry dates, you are using a call spread option strategy among the various other strategies in the market.
Call options may be purchased and sold on various products, including exchange-traded funds (ETFs), currencies, and swaps. Similarly, with an index call option, you can invest in an index. Whether you make a profit or not solely relies on how the value of the index changes. This is why there are Nifty 50 call option chains, Nifty Bank calls, etc.
Below is the nifty call put option price chart as of December 26, 2023:
Put option
With a put option, you have the authority to sell the underlying asset on the date that the contracting parties have decided upon at the strike price. However, the buyer doesn’t need to comply in the same way.
How does the call option work?
A call option contract is created when an option seller operates with an option buyer. In this case, the option seller grants the buyer the unrestricted right to purchase a certain security at a given price.
Regarding equity call options, each contract usually contains 100 shares. This indicates that the call option contract buyer may exercise the option to acquire 100 shares. However, a cost is associated with purchasing a call option contract: the option premium, which must be paid to the seller or writer of the contract.
The premium is paid to the seller in addition to the asset’s strike price. Since the seller is forced to fulfil his part of the contract even if the situation is unfavourable, the premium acts as compensation.
Additionally, upon expiration, there will be value if the underlying security’s spot price exceeds the contract’s strike price. As a result, there’s a good chance the call option will have intrinsic value or trade-in value. A call option’s intrinsic value indicates the seller may incur a loss and the buyer might gain after expiration.
How to choose a strike price for call options in India?
Risk tolerance:
Whether you choose an in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM) call option should depend on your level of risk tolerance.
Analyse the implied volatility:
Implied volatility is the degree to which the underlying asset in an options contract is likely to experience volatility. As implied volatility declines, contract premiums decrease, and vice versa.
Consider the intrinsic and time value:
The term “intrinsic value” describes an options contract’s intrinsic worth. When an option contract buyer believes the contract will go up in value before it expires, they are ready to pay more money than the inherent value, known as time value.
Conclusion
In India, trading options are an excellent method of participating in the market with a lower level of risk. However, ensure you have thorough knowledge and have done proper research before purchasing the best call options.
FAQs
Option calls are contracts that give the buyer the right to buy a stock or other asset at a fixed price before a certain date. Investors who are bullish or believe the price will rise use them. Option calls offer leverage and limited risk compared to buying the stock outright.
Yes, you can sell a call options first without owning the underlying stock, called as a naked call. However, this is a risky strategy, as you have unlimited loss potential if the stock price rises above the strike price and need to deposit a margin to sell a call option.
Yes, you can hold options till expiry, but there are some risks and implications involved. Depending on the type of options (stock or index, call or put) and whether it is in-the-money or out-of-the-money, you may have to pay taxes, fees, or margin, or face a physical or cash settlement.
A call option can be profitable if the underlying asset rises above the strike price before the expiration date. The profit depends on the difference between the asset’s spot price and the strike price, minus the premium paid for the option.
All kinds of individual traders may now learn about the concept of options trading. Buying and selling options might be a good idea but make sure you have ample knowledge, a thorough analysis, a margin account ready and an online broker available to assist you.
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