This article will examine “what is option contract in derivatives”.
An option contract is a type of derivative contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price and within a specified time frame.
Here are some points to understand option contracts in derivatives:
What is Option Contract in Derivatives?
An option contract is a financial contract between two parties, the buyer and the seller,
where the buyer has the right, but not the obligation, to buy or sell an underlying asset at a predetermined price and within a specified time frame.
- Types of options:
There are two main types of options: call options and put options.
A call option gives the buyer the right to buy the underlying asset, while a put option gives the buyer the right to sell the underlying asset.
- Strike price:
The strike price, also known as the exercise price, is the price at which the buyer can
buy or sell the underlying asset. The strike price is predetermined when the option contract is created.
- Expiration date:
The expiration date is the date when the option contract expires.
The buyer must exercise their right to buy or sell the underlying asset before the expiration date.
The premium is the price that the buyer pays to the seller for the option contract.
The premium is determined by several factors, including the current market price of the underlying asset, the strike price, and the expiration date.
If the buyer decides to exercise their option, they must notify the seller before the expiration date. If the option is in the money, meaning the current market price of the underlying asset is above the strike price for a call option or below the strike price for a put option,
the buyer can buy or sell the underlying asset at the strike price.
Option contracts can be risky because the buyer is not obligated to exercise their option, and they can lose the entire premium paid to the seller.
Additionally, the value of an option contract can be affected by several factors,
including the current market price of the underlying asset, volatility, and time decay.
Types of Options Contract
Overall, option contract in derivatives is complex financial instruments that can provide opportunities for investors to speculate on or hedge against price movements in underlying assets.
However, they are also risky and should only be used by investors who have a deep understanding of the underlying assets and the terms of the contract.
The types of options contracts in derivatives available in India are similar to those available in other markets, with some variations in terms of the underlying asset and trading rules. Here are some of the types of options contracts in derivatives in India:
- Equity Options:
Equity options are the most common type of options contract traded in India.
They are based on the underlying shares of companies listed on stock exchanges
such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).
- Index Options:
Index options are based on the performance of a stock market index such as the Nifty 50 or the BSE Sensex. They allow investors to gain exposure to the broader stock market rather than just a specific company's shares.
- Currency Options:
Currency options are based on the exchange rate between two currencies, such as the Indian Rupee (INR) and the US Dollar (USD). They are traded on the currency derivatives segment of stock exchanges.
- Commodity Options:
Commodity options are based on the price of a specific commodity such as gold, silver, crude oil, or agricultural products. They are traded on commodity exchanges such as the
Multi Commodity Exchange (MCX) and the National Commodity and Derivatives Exchange (NCDEX).
- Interest Rate Options:
Interest rate options are based on the yield of government bonds or other fixed income securities. They allow investors to hedge against changes in interest rates.
In addition to these basic types, there are also different styles of options contracts in India,
including American and European style options.
There are also variations such as weekly options and mini options, which have smaller contract sizes and shorter expiry periods. It's important to understand the specific rules and regulations governing options trading in India before getting involved in these markets.