Equity Options
There are two classes of options traded - call options and put options. An option contract is a leveraged product to participate in the rises and falls of share prices.
A put option is a contract conferring to the buyer of the contract the right but not the obligation to sell a defined quantity of shares at a given price before a stipulated time. Similarly a call option contract confers the right but not the obligation to buy.
An option is a security, just like a stock or bond, and constitutes a binding contract with strictly defined terms and properties. The value of a stock option is based on the underlying stock. In the case of an index option, its value is based on the underlying index.
Novice traders will prefer only to buy options and sell them to close a position, however short selling or “writing” option contracts is also possible for more experienced traders
An Option is a Derivative
That is, its value is derived from something else. In the case of a stock option, its value is based on the underlying stock. In the case of an index option, its value is based on the underlying index. There are two types of options traded - call options and put options.
An option is the right, but not the obligation, to buy or sell a stock (or other security) for a specified price on or before a specific date. A call is the right to buy a stock, while a put is the right to sell the stock. The person who purchases an option, whether it is a put or a call, is the option “buyer”. Conversely, the person who originally sells the put or call is the option “seller”.
The Parties to an Option
There are two parties to an equity option. There is the party who buys the option; and there is the party who sells the option. The party who sells the option is the writer. The party who writes the option has the obligation to fulfil the terms of the contract should it be exercised. This can be done by delivering to the appropriate broker the agreed number of the underlying security for each option written.
When to Use Options
Much like stocks, options can be used to take a position on the market in an effort to capitalize on an upward or downward market move.
Unlike stocks, however, options can provide an investor the benefits of leverage over a position in an individual stock or basket of stocks reflecting the broad market. At the same time, option buyers can also take advantage of predetermined, limited risk. Conversely, options writers assume significant risk if they do not hedge their positions. Once you hold a position in the market, you can hold until expiry, exercise or trade out of your position.
What Affects Option Index Prices?
There are several factors that affect the overall level of Index option prices – the underlying value, the option’s strike price, time until expiration, volatility, interest rates and dividends
The prices of calls and puts prior to expiration reflect both intrinsic value and time value of the option. The most important consideration is the index value compared to the strike price of the option. This determines whether the option is in or out of the money.
A call or put that is in the money has intrinsic value – the amount the holder would receive upon exercise.