Chapter 01 · Options fundamentals
How this options module is organised
This module is a map of the later chapters, not a replacement for them. Read it once so the jargon, the payoffs, and the chain sit in an order, then come back when a later chapter uses a word you only half remember.
What an option is, before the vocabulary
An option is a contract that gives the buyer a right, and gives the seller an obligation, related to a future transaction in an underlying. A call is the right to buy. A put is the right to sell. The buyer pays a premium up front. That premium is the most the buyer can lose, if the option is held as a simple long and the buyer does not add other positions. The seller receives the premium and can lose far more, because the seller has promised to take the other side if the buyer exercises the right.
Indian index and stock options that you will meet on the exchange are standardised: a named underlying, a strike, an expiry, and a lot size. They are not a private bet with a friend. The clearing corporation stands in the middle, and the seller posts margin because the seller’s loss is open-ended until the position is closed or expires.
The order the chapters follow
- The introduction sets the right and the obligation, and the difference between buying and selling.
- The jargon chapter names premium, strike, expiry, lot size, exercise, and the words people use loosely on a trading screen.
- Puts get their own chapter because a right to sell is not the mirror image of a call in the way beginners draw it.
- Payoff graphs show, at expiry, what a buyer and a seller have left after the premium. Before expiry the picture is less tidy, and the chapter should not be asked to pretend otherwise.
- Moneyness says whether the strike is already on the favourable side of the underlying price, and why that is not the same as ‘this option will make money’.
- The Greeks are sensitivities: how the premium tends to change when the underlying, time, volatility, or interest rates change. They are partial answers, each holding the other inputs still.
- The option chain is the live table of strikes and expiries. It is where the earlier words become quotes you can trade, and where open interest and volume describe the crowd rather than the value.
Three distinctions that prevent most early confusion
| People say | The precise version |
|---|---|
| I bought an option, so my risk is small. | Your risk is the premium if you simply hold a long option to expiry. It is not small if the premium itself was a large part of your capital, and it is not capped if you later add a short option. |
| The option is cheap because the premium is ₹4. | Cheap compared with what? A ₹4 premium on a ₹20 stock and a ₹4 premium on a ₹40,000 index are unrelated. Compare the premium with the underlying, the strike distance, the time left, and a volatility you can explain. |
| Open interest rising means the market will go up. | Open interest counts contracts that remain open. It does not record whether the new trades were opened by people who will be glad. |
How to use the rest of the module
Do not try to trade a combination after reading only the introduction. The combination chapters in the next module assume you can already read a payoff at expiry and can say, in one sentence, who has the obligation. If you cannot, go back. A spread is not a milder version of a hunch. It is two contracts, each with a premium and a margin, and the loss is defined only if both legs stay on.
When a number appears — a Greek, a premium, a breakeven — write the unit beside it. Rupees per share, rupees per lot, a percentage of the underlying, or a change per day. Half of the mistakes in this subject are unit mistakes. The other half are forgetting that a picture drawn at expiry is not a picture of next Tuesday.
What to remember
- The buyer holds a right and pays a premium. The seller takes an obligation and posts margin.
- Read the chapters in order the first time. The chain will not make sense if payoff and moneyness are still vague.
- A small premium can still be a large fraction of the money you brought.
- Pictures at expiry and prices before expiry answer different questions.
- Write the unit next to every options number you copy down.