NISM Series-8 l Chapter 4 : Introduction to Options Part-1 l Equity Derivatives Certification Exam

An option is a contract that gives the holder of the option the right, but not an obligation,
to buy or sell the underlying asset on or before a stated date/day, at a predetermined
price. This right can be bought for a price known as the option premium. The party taking
a long position i.e., buying the option is called buyer/ holder of the option and the party
taking a short position i.e., selling the option is called the seller/ writer of the option. The
option buyer must pay the premium to the option seller upfront, i.e., at the time of buying
the option.
The option buyer or holder has the right but no obligation with regards to buying or selling
the underlying asset, while the option writer has the obligation in the contract. Therefore,
the option buyer will exercise his option only when the situation is favourable to him. On
the other hand, the option writer is legally bound to honour the contract whenever the
option buyer decides to exercise his option.,
Options may be categorized into two main types:
• Call Options
• Put Options
An option, which gives the buyer/holder a right to buy the underlying asset, is called a çall
option; and an option which gives the buyer/holder a right to sell the underlying asset, is
called a ’put option’.
Index option: These options have a stock index as the underlying asset. For example,
options on Nifty, Sensex, etc.
Stock option: These options have individual stocks as the underlying asset. For example,
option on ONGC, NTPC, etc.
Buyer of an option: The buyer of an option is one who has a right but not the obligation
in the contract. For owning this right, he pays a price called ‘option premium’ to the seller
of this right. He has a right to buy the underlying asset in case of a call option and the
right to sell the underlying asset in case of a put option.
Writer of an option: The writer of an option is one who receives the option premium and
is thereby obliged to sell/buy the asset if the buyer of option exercises his right. He has a
sell obligation in case of a call option (i.e., when the call option holder exercises his right
to buy) and a buy obligation in case of a put option (i.e., when the put option holder
exercises his right to sell).
American option: The owner (buyer/holder) of an American option can exercise his right
at any time on or before the expiry date/day of the contract.
European option: The owner (buyer/holder) of a European option can exercise his right
only on the expiry date/day of the contract. In India, all index and stock options are
European style options.
Option Premium: It is the price which the option buyer pays to the option seller. In our
examples, the option premium is Rs. 124.50 for the call option and Rs. 177.60 for the put
option, both having a strike price of 18400 and expiring on May 25, 2023. The premium
mentioned here is for a single unit of Nifty options and to arrive at the total premium for
the contract, we must multiply this premium with the lot size.
Spot price (S): It is the price at which the underlying asset is trading in the spot market.
In our examples, it is the value of underlying index (Nifty 50) which was 18315.10 at that
point of time.
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