Option Terminology that you must know

Here we discuss the basic terminology of the option trading. Before moving to this topic, I would like to inform that we have shared the basic of option and Option contracts. If you are a complete beginner then your visit will be recommended for that topics. Basic terminology of option trading goes below:
  • Strike Price
  • Underlying
  • Exercising of an option contract
  • Option Expiry
  • Option Premium
Now time to understand each of these terms separately. I will bring the home example to grasp the concept. The home example we have discussed in our first post. We will also recall the example of the stock taken in second post.

Strike Price : The strike price as the anchor price at which the two parties (buyer and seller) agree to enter into an options agreement. The reference price of the home is the strike price for it. In this case it is Rs. 40,00,000. And it is Rs. 105 in our stock example taken in our second post.

Underlying: As we know, a derivative contract derives its value from an underlying asset. The underlying price is the price at which the underlying asset trades in the spot market.
In home example, The underlying was one home that buyer have to buy. In stock example, it is stock that buyer willing to buy. Another thing that you need to know in stock option, we have to buy it in a lot. The lot size is fixed.

For example, if you want to buy an option of Nifty, you have to buy it in the multiple of 75 as lot size of nifty is 75 as of now. You cannot buy 70 or 80. You have buy either 75 of multiple of 75.

In home case, you cannot buy 0.75 or 1.25 of home, you have to buy one home at a time.

Exercising of an option contract : The act of claiming your right to buy the options contract at the end of the expiry. If you ever hear the line “exercise the option contract” in the context of a call option, it simply means that one is claiming the right to buy the stock at the agreed strike price. Clearly he or she would do it only if the stock is trading above the strike.

Option expiry : A future date on or before which the options contract can be executed. Options contracts have three different duration you can pick from:
  • Near month (1 month)
  • Middle Month (2 months)
  • Far Month (3 months)

Let an example of SBIN, if you want to buy an option of SBIN in February, 2020, you can any of three expiry mentioned above.
For this case, Near month will be February, Middle Month will be March expiry and Far month is the April Expiry.
Option Analogy with Home Example

Each expiry expires on the last Thursday of the month in general situation.
In case of Nifty and bank nifty, we have weekly expiry as well which expires on each Thursday of the month.

Premium: The upfront payment made by the buyer to the seller to enjoy the privileges of an option contract.

It was Rs. 8,00,000 lakh in home case and Rs. 10 in our stock example.

Here we have discussed the option terminology. We will bring more in up coming days. Stay tuned.
Happy Trading. 

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