As the name implies, options allow you the opportunity but don’t impose the obligation to buy or sell a financial asset.
Options trading – What is it?
Options trading might appear to be more difficult than it is. If you’re seeking a simple definition of options trading, look no further. Options trading is the sale of products that give investors the option to buy or sell a specific security on a specific date at a specific price during a specific timeline. A contract that is tied to an underlying asset, such as a stock or bond, is known as an option. If you choose to carry out the contract, this is known as exercising the choice.
But, without delving into the complexities of these instruments, let’s first grasp some of the important terminology (jargon) utilised in trading options.
The following are some option trading terms every investor should be aware of:
- Underlying price: An options contract derives its value from an underlying asset and the price at which this asset currently trades in the spot market is called the underlying price.
- Strike price: The strike price is the price at which the options transaction can be exercised. It is defined for every option and is fixed. Irrespective of what happens in the market, the strike price remains the same throughout the duration of the options contract. For instance, you own a call option for the stock of a company at the strike price of Rs. 100. Even if the market fluctuations cause the current market price (also called the spot price) to come down to Rs. 50 or soar up to Rs. 200, you can exercise the call only at Rs. 100.
- In the Money (ITM): As the term implies, ITM refers to anything that is already earning money. In a call option, this means that the strike price is less than the market price. Conversely, a put option is in the money if the strike price is more than the market price.
- At the Money (ATM): An at the money situation in an options contract is when the fundamental stock’s spot price and strike price are identical. So, ATM options, if exercised, won’t make any profit but they still have value since before the contract expires, they may end up in the money.
- Out of the Money (OTM): A contract is deemed OTM whenever the strike price of a call option is more than the underpinning asset’s spot rate. Whenever the strike price of the underpinning asset is less than the spot price of a put option, such a contract is said to be out of money.
The ability to generate such a large exponential yield is what makes options trading an appealing trading product. That’s one of the reasons why options are a popular trading product amongst investors.