Why in the news
Options, a popular kind of derivative, are in focus; these notes cover the basics a banking or finance aspirant should know.
Key facts
- An option is a derivative: its value comes from an underlying such as a stock, index or ETF.
- The holder may buy or sell at the strike price on or before the expiry date but is not bound to.
- The buyer pays a premium; if terms are unfavourable the option just lapses and only the premium is lost.
- The seller (writer) keeps the premium but must perform if the buyer exercises.
- Index options use an index such as Nifty or Bank Nifty; stock options use a single share.
Call, put and exercise style
| Item | What it means |
|---|
| Call | Right to buy at the strike price |
| Put | Right to sell at the strike price |
| American style | Exercise any time up to expiry |
| European style | Exercise only on expiry day |
Common strategies
| Strategy | Action | View |
|---|
| Long call | Buy a call | Price will rise |
| Short call | Sell a call | Price will fall or stay flat |
| Long put | Buy a put | Price will drop |
| Short put | Sell a put | Price will stay above strike |
| Long straddle | Buy call and put at one strike | High volatility |
| Short straddle | Sell call and put at one strike | Low volatility |
Moneyness
- In-the-money (ITM): exercise pays; call when spot is above strike, put when spot is below.
- At-the-money (ATM): spot equals strike, so no gain or loss.
- Out-of-the-money (OTM): exercise would lose; call when spot is below strike, put when spot is above.
Exam angle
- Buyer: limited risk; seller: obligation.
- Success needs grasp of market movement, pricing and risk management.