Options are a form of derivative contract (financial contracts that derive their value from an underlying asset which could be stocks, indices, commodities, currencies, exchange rates, or the rate of interest) that gives buyers of the contracts (the option holders) the right (but not the obligation) to buy or sell a security at a chosen price at some specified point in the future. These financial instruments help you make profits by betting on the future value of the underlying asset.
Options are divided into two kind of contracts i.e. call and put.
Call Option: The buyer of the contract purchases the right of buying the underlying asset in the future at a predetermined price, called exercise price or strike price.
Put Option: The buyer acquires the right of selling the underlying asset in the future at the predetermined price, called exercise price or strike price (same as for the call option).
Premium: The amount charged on the option buyers by the sellers for their right is known as the premium amount.
If the market prices be unfavorable for option holders, they will let the option expire worthless and not exercise this right, ensuring that potential losses are not higher than the premium. On the other hand, if the market moves in the direction that makes this right more valuable, the holder may choose to exercise the contract (within the timeframe of the particular contract).
Strike price/reference/exercise price: The strike price of an option is the price at which the trader wants to exercise a put or call option before the expiration of a particular option.
Breakeven point: For a call buyer, the breakeven point is reached when the underlying asset is equal to the strike price plus the premium paid, while the BEP for a put position is reached when the underlying asset is equal to the strike price minus the premium paid.
Buy: When a trader buys an option, it remains valuable only if the price closes the option’s expiration period “in the money.” That means either above or below the strike price. (For call options, it’s above the strike; for put options, it’s below the strike.)
Sell: When a trader sells an option, it remains valuable only if the price closes the option’s expiration period below the strike price.
[…] Types of Gap: […]
[…] an investor to yield a profit, the price of the security has to decrease before its exercise date. Buying a put option grants the rights to sell the security at a fixed price within the exercise […]
[…] an investor to yield a profit, the price of the security has to increase before its exercise date as opposed to a put buyer whose outlook is bearish. The purchaser of a put option would be paying a […]