Part 3 Learn Institutional Trading

Understanding Options

An option is a financial contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price, called the strike price, before or on a specific date known as the expiry date. Options are derivatives, meaning their value is derived from an underlying asset like stocks, indices, commodities, or currencies.

Types of Options

Call Option
A call option gives the buyer the right to buy the underlying asset at the strike price. Buyers expect the price to rise.

Example: If Infosys stock trades at ₹1500 and a trader buys a call with a strike price of ₹1550 for ₹30, they can purchase the stock at ₹1550, even if it rises to ₹1600.

Put Option
A put option gives the buyer the right to sell the underlying asset at the strike price. Buyers expect the price to fall.

Example: If Infosys stock trades at ₹1500 and a trader buys a put with a strike price of ₹1450 for ₹25, they can sell the stock at ₹1450, even if it drops to ₹1400.

Option Pricing and Factors Affecting Value

Option pricing is influenced by several variables, known as the Option Greeks:

Delta (Δ): Measures how much the option price moves with a ₹1 change in the underlying asset.

Call options have positive delta; put options have negative delta.

Gamma (Γ): Measures how delta changes as the underlying asset moves.

Theta (Θ): Represents time decay – the rate at which an option loses value as expiry approaches.

Vega (V): Sensitivity to volatility in the underlying asset. High volatility increases option premiums.

Rho (ρ): Sensitivity to interest rate changes.

Other factors include:

Underlying asset price

Strike price relative to market price

Time to expiry

Market volatility

Understanding these factors is crucial for effective trading and risk management.