Futures and Options – The basics.

Options: Option styles

OPTION STYLES.

By style we mean the ‘excerciseability’ of an option contract – whether the option contract can be exercised before the expiration date or not.

TWO STYLES: American & European.

Options traded all over the world are divided into two broad styles called American options and European options.

What’s the difference?

An American option can be ‘exercised’ any time before the option expiry. European options can be exercised only on the expiry date.

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Options: Premium

OPTIONS: PREMIUM

In one sentence – Option premium is the price of an option contract.

Pay premium to whom?

The premium is paid upfront by the buyer of the option to the seller. Option premium is not a fixed amount. It keeps changing according to the Moneyness status of an option. For an in-the-money option, the premium quoted will be more than an out-of-the-money option. As the option keeps moving in the money, the premiums will also increase..

Premium is different from brokerage.

The premium paid by the buyer to the seller should not be confused with the brokerage costs normally incurred to trade in options market.

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Options: Moneyness.



MONEYNESS.

As described in our last topic on strike price, ‘Moneyness’ explains the relationship between strike price of an option and the spot price of the underlying stock. There is a ‘gap’ or a difference between the strike price of an option and the spot price of the underlying stock. Moneyness trys to express the quality of that gap in terms of money value. I.e., whether the gap would result in a profit /loss for the option trader. So, Moneyness basically refers to the current state of the option in terms of profit and loss.

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Options: Understanding strike price.


STRIKE PRICE

One feature of options contract that may baffle a naïve option user is the concept of ‘strike price’ or ‘exercise price’ and the range of strike prices that are available in a particular month.

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