Education Series on Derivative Contracts
As mentioned earlier options are another important derivative
product that has widely been used in the stock market. It gives good
trading opportunities with higher leverage of funds and one could make
attractive gains if trading positions were taken on the basis of good
assessment as far as the probable movement of the asset value is
Option can be defined as a derivative contract which gives the holder
a right, but no obligation, to buy or sell a specified quantity of the
underlying asset on a future date at the predetermined price.
Accordingly, an option contract consists the following.
Two parties, option buyer and option seller. Option buyer, also known
as the option holder enjoys the right to purchase or sell the
underlying as per the terms of the contract. However, it is not
obligatory from his side that this right has to be executed. In other
words, the buyer has absolute freedom to walk away from the contract if
he feels that the terms of the contract are not in his favour.
Option Seller, also known as option writer is obligated to buy or sell
as per the contract terms provided the buyer comes forward to execute
Underlying, The agreement is drawn on a specified quantity of an asset
or assets and this is known as the underlying.
Strike Price, Both the parties have agreed to transact the business at
a particular price and this will be recorded on the contract. This is
called the strike price or the exercise price.
Expiry Date, The contract will be valid upto a certain point of time as
recorded on the document and this is called the expiry date.