These markets allow options contracts to be traded. Let’s understand options in a simple way.OPTION is basically a contract which would give a BUYER OF OPTION, a right to buy an underlying asset and an obligation to the SELLER OF OPTION to sell such underlying asset at a specified price on or before a certain date.
In the same way, AN OPTION can also give a BUYER OF OPTION, a right to sell an underlying asset and an obligation to the SELLER OF THE OPTION, an obligation to buy such an underlying asset at a specified price on or before a certain date.
The first case is called CALL OPTION, and the second case is called PUT OPTION. So, these contracts are given a platform to trade and are called OPTIONS MARKETS. So to sum up the kind of traders in OPTIONS MARKETS, we would be able to see the four kinds
- BUYER OF CALL OPTION(Call holders)
- BUYER OF PUT OPTION(Put holders)
- SELLER OF CALL OPTION(Call writers)
- SELLER OF PUT OPTION(Put writers)
For instance, if a share price is expected by trade to move up, he takes an option to buy at a specified price usually below his expected price. He pays an amount to the “SELLER OF THIS CALL OPTION.” This amount is termed as premium in OPTIONS MARKETS.
On or before the specified date, if PRICE goes above the price agreed, he stands at the profit, since he has the right to buy the stock at an agreed price. Say in our example, each. He buys an option to buy 100 shares at Reach. If the price moves to 520, he is in profit since he can buy shares from SELLER OF CALL OPTION at 500 when the prevailing market price happens to be 520. To sum up, he can exercise his OPTION and buy at 500 and sell the shares at 520 and make profits.
Let’s discuss the other way also if PRICE comes down to 450; he would not exercise his OPTION to buy shares from the SELLER OF CALL OPTION. The reason behind this is that the buyer of any OPTION WILL HAVE only the option and NOT the obligation. Since exercising the option will lead to losses, the buyer of the call OPTION will have to bear the loss of the premium that he paid to the SELLER OF CALL OPTION. Let’s also know the buyer of any option is called “holder of the option ” and the seller of any option is called ” writer of the option.”
Option Market Uses
OPTIONS are used for mainly two purposes. One happens to be for a speculative purpose, and the other one happens to be for hedging purpose.Options can be used for to make extra income also.
In the above example that we discussed, the trader expected that price rise would happen in the near future and accordingly took a call option to get gains out of the price rise expectation. So people who expect PRICE rises will buy OPTIONS which give them the right to buy a stock at a price lower than their expectation. On the other side, people who expect a price fall in the near future will buy option to sell the stock at a price above their expected price, so that they can make money out of the fall. This is speculation in simple terms.
Investors who already hold some stock in their portfolio would be keen on protecting their value from future price falls. Therefore they get into options to sell the stock at a higher price than their expected fall. They buy a put option in this case . If the price falls, they can exercise the right to sell, and get the gain from OPTION MARKETS to compensate with the loss in equity markets.
Types of Option Based on Exercise
Based on various criteria we have AMERICAN OPTIONS, EUROPEAN OPTIONS, LONG TERM EQUITY ANTICIPATION SECURITIES, EXOTIC OPTIONS, etc .,
Most commonly discussed types are AMERICAN OPTIONS wherein options can be exercised any time between the date we bought and the expiry date, AND EUROPEAN OPTIONS, wherein options can only be exercised at the end of their life.
It is highly risky to enter into OPTION MARKETS without having requisite knowledge, skills, and experience. Most people think that they could make enormous profits in OPTION MARKETS and they try to take either of the two positions on a random basis. It is advisable to take positions only with the requisite knowledge.
OPTION MARKETS have wonderful information which influences the equity markets. One can master in reading the OPTION CHAIN CHART to decode the clues and then accordingly take positions in equity markets. OPTION MARKETS ALWAYS REMAIN A TEMPTING POINT for it can make a pauper into a rich guy. However, losses can be at high levels if calculated risks are not taken.