Options basics

What an option is

An option is a contract that gives its buyer the right, but not the duty, to buy or sell something at a fixed price on expiry. The buyer pays the seller an amount called the premium for that right. In India, options on indices such as the Nifty 50 and on selected shares trade on NSE and BSE.

Calls and puts

• Call option: the right to buy at the strike price. At expiry it has value if the price is above the strike.
• Put option: the right to sell at the strike price. At expiry it has value if the price is below the strike.

The key terms

• Strike price: the fixed price written into the option. Each expiry has a range of strikes.
• Premium: the price of the option, paid by the buyer to the seller. It is quoted per unit; one lot covers many units.
• Expiry: the last day of the contract. Index options in India are settled in cash at expiry.
• Lot size: the number of units in one contract, set by the exchange. The lots page has current figures.

In, at and out of the money

• In the money (ITM): a call whose strike is below the current price, or a put whose strike is above it. It would have value if it expired now.
• At the money (ATM): the strike closest to the current price.
• Out of the money (OTM): a call whose strike is above the current price, or a put whose strike is below it. It would expire worthless if prices did not move.

What the premium is made of

An option’s premium has two parts. Intrinsic value is what it would be worth if exercised now (zero for OTM options). Time value is the rest: what is paid for the chance the price moves before expiry. Time value shrinks as expiry approaches and is zero at expiry.

Buyer and seller: different risks

The buyer of an option can lose at most the premium paid. The buyer’s gain on a call has no fixed limit; on a put it is limited only by the price falling to zero.

The seller (or writer) receives the premium, and that is the most the seller can gain. The seller’s possible loss is much larger, and for a call it has no fixed limit. Because of this, sellers must keep margin with their broker, as in futures.

Payoff at expiry

At expiry, a call is worth the price minus the strike, or zero if that is negative. A put is worth the strike minus the price, or zero. The buyer’s result is that value minus the premium paid; the seller’s result is the opposite. For example, a call with a strike of 100 bought for a premium of 5 makes money at expiry only above 105, the break-even point.

Before expiry, option prices also depend on time left and on expected volatility; the option Greeks topic explains how.

Expiry days and the November 2024 changes

From November 2024, SEBI limited weekly expiries to one benchmark index per exchange, so other indices have only monthly expiries. Expiry days are set by the exchanges and have changed since, so the option chain page shows the expiries currently on offer.

SEBI’s study of FY2022 to FY2024 found that about 9 in 10 individual traders in equity F&O made a net loss.