THE equity market has become volatile due to low volumes towards the end of the year. The volatility is making investors run for cover and has thrown open a lot of 'speculative' opportunities for short-term traders. No wonder, the demand for options as a financial instrument has gone up in the recent past. Let us see what is an option?
An option is the right but not the obligation to buy or sell an asset at a specific price in a specific period in the future. Options are of two types: call option, which gives the person the right to buy the asset on or before a specific date.
For example, Ashok buys a call option to buy 50 (one lot) S&P CNX Nifty on NSE at 6,000 for December at a premium of 45. Second, put option which gives the person the right to sell the asset on or before a specific date. For example, Ashok buys a put option to sell 50 (one lot) of S&P CNX Nifty on NSE at 5,900 for December month at a premium of 12.
Further, options can be divided into two categories – European and American.
Ø European options can be exercised by the holders on the date of expiry
Ø American options can be exercised on or before the date of expiry.
Options are effective insurance for the one who buys the options. If you are holding some shares and worried about some event eroding the stock price in near future, you may consider buying a put option that allows you to sell the shares at a the predetermined price, even if the price on the expiry date falls below the predetermined price. The premium that you pay for this right is the price for the insurance you buy. For the option sellers, the contract fetches an obligation to buy or sell if the option is exercised. Of course, the sellers get to pocket the premium if option is not exercised.
