What are the Features of Options?

To understand options, one needs to understand options features and option contract features. These options features and option contract features refer to the basic DNA of an option contract. Apart from understanding the gist of an options contract, we also look at some of the key features of options.

What are the Features of Options Contracts?

Let us start by looking at 8 very special features of options contracts in India.

1. First and foremost, the option is a contract and not an asset class. You cannot hold options in your Demat account as it is not an asset that creates ownership. It is just a right to buy or to sell an underlying asset and the value of the option is derived from the underlying asset which could be an equity shares and bonds, index or commodity.
2. Since an Option is a right, the person who gets the right is at an advantage since one party gets the right and the other party gets the obligation. The party that gets the right will have to pay a price to the party that gets the obligation. This price is called the price of option or option premium. This is one of the key features of an options contract,
3. Every option must have a strike price/exercise price which is the rate at which the owner of the option can buy or sell the underlying stock. The strike price is also the contract price and that cannot change. It is only the market price of the stock or asset that changes, the strike price does not change.
4. All options are traded in lot sizes or contract sizes. You can trade in the minimum lot size or multiples thereof. This is a form of standardization of options contracts that makes it possible to be exchange-traded.
5. Every option has an expiration date on which the option or the right becomes worthless if nothing is done. If you don’t close your position or exercise option on the last day of expiry, then the option automatically expires on the last day. Inequity options, you have near-month contracts, mid-month contracts, and far-month contracts.
6. Every option has an intrinsic value, which is the extent to which the option is in-the-money. For example, a call option on RIL with a strike of Rs.2,200 and a stock price of Rs.2,220 has an intrinsic value of Rs.20. The actual price of the option will normally be higher because the price of the option includes the intrinsic value and time value. Normally, OTM and ATM options only have time value and no intrinsic value.
7. In India, all equity and index options are mandatorily settled only in cash. That means any profit or loss on the option, net of brokerage, and statutory charges will be either credited or debited to your trading account. All contracts are cash-settled irrespective of whether you exercise the option, sell the option or leave the option to expire.
8. Finally, let us reiterate the most important aspect of an options contract. The investor has the option to buy or sell the underlying asset by the expiration date. But he is under no obligation to purchase or sell. The option buyer will only exercise the option if the price is favorable. Else, the buyer just forfeits the premium paid and lets the option expire.

What are the different types of options?

Options classification can be done in 3 different ways as under.

• The first is the classification between call and put options. A call option is the right to buy an underlying asset while a put option is the right to sell an underlying option. Normally call options are bullish in view and put options are bearish in view. In both call and put options, the buyer has the right but not the obligation to buy or sell an underlying asset.
• The second classification is concerning moneyness. Calls can be in-the-money or ITM; at the money or ATM and Out of the money or OTM. ITM options are those options that have positive intrinsic value i.e., where the stock price is higher than the strike price in the case of call options and stock price is lower than the strike price in the case of put options. OTM options and ATM options normally have only time value but zero intrinsic value. Normally, ATM options are expanded to include near the money or NTM options too.
• Options can also be either American or European. For example, American options can be exercised any time before the expiry while European options can only be exercised on the day of expiry. In the past, stock options were American options and index options were European options in India. Since 2010, all options in India are European only.

How does options trading works?

Options trading works almost like cash market trading in terms of order flows. However, here you need to make a selection in terms of contracts by looking at the strike price, month of expiry, market premium and cross-check option premiums with the Black & Scholes calculator embedded in the system.