Options Jargons

In the previous chapter, we delved into the fundamental structure of a call option. Our goal was to grasp some key concepts of call options, such as:

1. Buying a call option is beneficial when you anticipate the underlying price to rise.

2. If the underlying price remains the same or decreases, the call option buyer incurs a loss.

3. The loss for the call option buyer is limited to the premium paid to the call option seller/writer.

However, before we proceed, it’s crucial to break down a few basic option-related terms. Understanding these jargons at this stage will not only reinforce our knowledge but also make the upcoming discussion on options more accessible and easier to grasp.

 Karun and Ankit’s agreement on the land sale serves as a perfect real-world example to explain some key terms used in options trading. Let’s break down the jargon and see how it applies to their story.

1. Strike Price

The strike price is the agreed-upon price at which the option buyer can purchase the underlying asset. In Karun and Ankit’s case, the strike price is Rs. 40,00,000. This is the price Karun has the right to buy the land for within the specified period.

2. Underlying Price

The underlying price is the current market value of the asset in the scenario. For Karun and Ankit, it’s the market value of the land. If the metro project proceeds, the underlying price of the land could rise significantly above the strike price, making the option valuable for Karun.

3. Exercising of an Option Contract

 

Exercising an option means the buyer decides to go through with the transaction. Karun would exercise his option if the land’s market price exceeds Rs. 40,00,000, allowing him to buy the land at the lower strike price and potentially sell it for a profit.

4. Option Expiry:

The option expiry is the date by which the option must be exercised. In their agreement, this period is six months. If Karun does not exercise his option within these six months, his right to buy the land at Rs. 40,00,000 expires.

5. Option Premium

The option premium is the price paid for the option itself. Karun paid Ankit Rs. 5,00,000 as the option premium. This amount is non-refundable and compensates Ankit for agreeing to sell the land at the strike price within the specified period.

6. Option Settlement:

Option settlement refers to the transaction of the option contract when it is exercised or expires. If Karun exercises his option, the settlement involves Karun paying Rs. 40,00,000 to Ankit to purchase the land. If Karun doesn’t exercise the option, the settlement involves Ankit keeping the Rs. 5,00,000 premium, and no land transaction occurs.

Understanding Call Options with Reliance Industries: A Real Stock Market Example

Now that we have a solid grasp of call options and various related jargons, let's dive into a real stock market example to further strengthen our understanding. For this, we'll use Reliance Industries, one of India's largest and most influential companies.

 Currently, Reliance’s share is trading at Rs. 2800. Now to proceed further, we need to select an agreed price, known as the strike price, and for this, we'll refer to something called an option chain.

The table shown above is referred to as an 'Option Chain'. You can access the Option Chain by clicking on the F&O option, located at the top left next to the cash option in Tick2Trade  (highlighted in Red).This table displays various strike prices available for a particular contract, along with their associated premiums.

Additionally, the option chain provides a wealth of trading information, including Open Interest, volume, bid-ask quantity, and more. However, for now, we recommend focusing solely on the highlighted information.

We will use a strike price of Rs. 2900 and frame a scenario where we bet on call options, explaining all the related terms and jargon along the way.

Imagine you're a trader who believes that Reliance Industries' share price will rise significantly in the next month due to positive market trends and strong quarterly results. To capitalise on this anticipated price increase, you decide to buy a call option on Reliance with a strike price of Rs. 2900.

Strike Price

The strike price is the agreed price at which you can buy the underlying asset (in this case, Reliance shares) if you decide to exercise the option. Here, Rs. 2900 is our strike price. This means you have the right, but not the obligation, to buy Reliance shares at Rs. 2900 regardless of their market price at the time of expiry.

Underlying Price

The underlying price is the current market price of the asset. As of now, Reliance’s share is trading at Rs. 2800. This is the price in the spot market, and for your call option to be profitable, Reliance’s share price needs to rise above Rs. 2900.

 Option Premium

To enter into this call option contract, you need to pay an option premium. Let's say the premium for the Reliance call option with a strike price of Rs. 2900 is Rs. 50 per share. This premium compensates the seller of the option for taking on the risk and gives you the right to buy Reliance shares at Rs. 2900 before or at the time of expiry.

Option Expiry

Options contracts have a specific expiry date, which is the last day you can exercise your option. For simplicity, let's assume our call option on Reliance expires in one month. In the Indian stock market, equity options typically expire on the last Thursday of each month.

Exercising the Option Contract

Exercising the option means claiming your right to buy Reliance shares at the strike price of Rs. 2900. If, at the expiry, Reliance is trading above Rs. 2900, you would exercise your option to buy the shares at the lower strike price and benefit from the price difference.

Scenarios and Outcomes

Scenario 1: Price Rises to Rs. 3100

If Reliance’s share price rises to Rs. 3100 by the expiry date, you would exercise your option. You buy Reliance shares at the strike price of Rs. 2900. Including the premium you paid (Rs. 50 per share), your total cost per share is Rs. 2950. Since the market price is Rs. 3100, your profit per share is Rs. 150 (Rs. 3100 - Rs. 2950).

Scenario 2: Price Stays at Rs. 2800

If Reliance’s share price remains at Rs. 2800 by the expiry date, you would not exercise your option. It doesn't make sense to buy at Rs. 2900 when the market price is lower. You lose the premium paid (Rs. 50 per share), but you avoid a larger loss by not purchasing the shares at a higher price.

Scenario 3: Price Falls to Rs. 2700

If Reliance’s share price drops to Rs. 2700 by the expiry date, similar to Scenario 2, you would not exercise your option. You lose the premium paid (Rs. 50 per share), but you avoid an even greater loss by not buying the shares at Rs. 2900 when the market price is lower.

Option Settlement

Option settlement is the process of finalising the transaction. In this example, if you exercise your option (Scenario 1), you would pay Rs. 2900 per share and receive the shares. If you do not exercise your option (Scenarios 2 and 3), the option expires worthless, and you lose the premium paid.

We hope that understanding these terms in the context of a real stock like Reliance Industries has helped demystify the world of options trading. With this knowledge, you can make informed decisions and navigate the market with confidence.

Before we wrap up this chapter, let's explore one more important aspect: "How to buy options in Tick2Trade or on any other broker."

To do this follow these steps-

1. Open the Trading Platform and Log in to Tick2Trade or your preferred broker's trading platform.

2. Access the Search Bar -Locate the search bar, typically found at the top of the trading interface.

3. Search for the Option: Enter the name or ticker symbol of the stock, in this case, "Reliance Industries," and specify the strike price, like "RELIANCE 2900." The search results will display various call and put options at the strike price of 2900.

4. Select the Desired Call Option: In the search results, find the desired call option (denoted as "CE" for Call European style) and click on it.

It would look somewhat like this.

5. Here the details shown are -

Underlying Asset Name:- The name of the asset, here it is RELIANCE.

Expiry Date:- Options on stocks in the Indian market expire on the last Thursday of the 

month. For our example, the expiry date will be the last Thursday of May. Remember, stocks have monthly expiries, while indices can have both weekly and monthly expiries.

Strike Price: 2900, the price at which you have the right to buy the stock.

Option Type: CE, which stands for Call Option.

6.To place your orders you will have two options to do this either 

  Through Charts:-If you are using TICK2TRADE, you can place buy and sell orders directly through the charts by clicking the buy/sell buttons on the top left corner.

Or  Through F&O Section: Alternatively, you can go to the F&O section, select the desired strike price, and place your order under the trade option.

7. Here at the top left you can see Maximum Profit Shown as infinite because the underlying asset can rise indefinitely and then Maximum loss which is calculated as the quantity multiplied by the premium. For example, if the premium is Rs. 83.45 and the quantity is 250, the maximum loss would be Rs. 20,787.

There are various other Terms which are POP (Probability of Profit), delta, theta, etc., which we will cover in later chapters.

8. While placing the Order you will see these options 

   Buy Order:- Indicated by "B" for buying.

   Expiry:- Confirm the expiry date, which is the last Thursday of the month.

   Strike Price and Option Type:- Confirm the strike price (2900) and option type (CE).

   Quantity and Price:- Enter the quantity and check the trading price.

   Order Type:-Select the order type (limit or market) and place your order.

By following these steps, you can easily buy options using TICK2TRADE or any other broker's platform. 

Now we hope these concepts are clearer and more approachable. With these insights, you're now ready to make informed trading decisions and confidently navigate the complexities of the market.

In the next chapter, we will delve into PUT options and explore their intricacies.