Part 4 Learn Institutional Trading

Introduction to Options

Financial markets provide several instruments to trade and invest. Among equities, futures, commodities, and currencies, options trading has gained significant popularity worldwide, including India. Options are not just speculative tools; they are also powerful instruments for hedging, income generation, and risk management.

An option is essentially a derivative contract—its value is derived from an underlying asset like a stock, index, commodity, or currency. Unlike direct stock ownership, an option gives the buyer rights but not obligations. This unique feature makes them versatile but also complex for beginners.

To truly master options, one must understand not only the basic definitions but also pricing, market psychology, and strategies.

Basic Terminology

Before diving deeper, let’s go through the essential terms:

Option Contract: Agreement between buyer and seller based on an underlying asset.

Underlying Asset: Stock, index, commodity, or currency.

Strike Price: Pre-decided price at which the option can be exercised.

Expiry Date: The last date on which the option can be exercised.

Premium: Price paid by the buyer to acquire the option.

Lot Size: Minimum quantity for which an option can be traded.

European vs. American Options: European can be exercised only on expiry; American anytime before expiry.

How Options Work in Practice

Option buyers have limited risk (premium paid) but unlimited profit potential (in calls if stock rises, in puts if stock falls).
Option sellers have limited profit (premium received) but potentially unlimited risk.

This asymmetric payoff structure creates a market where traders, hedgers, and institutions interact.