Beginner · 6 min read

What is an option?

Calls, puts, strike, expiry, premium and lot size: the building blocks of every options strategy.

An option is a contract that gives the buyer a right, but not an obligation, to buy or sell an underlying (such as the NIFTY 50 index or a stock) at a fixed price on or before a fixed date. The buyer pays a price for this right, called the premium.

The two kinds

• A call option (CE) gives the right to buy at the strike price. Buyers of calls gain when the underlying rises well above the strike.
• A put option (PE) gives the right to sell at the strike price. Buyers of puts gain when the underlying falls well below the strike.

The words you will see everywhere

• Strike price: the fixed price written into the contract.
• Expiry: the date the contract ends. Index options have weekly and monthly expiries; the exchange decides which days apply, so check the current exchange circular.
• Premium: the price of one unit of the option, quoted per unit.
• Lot size: options trade in fixed lots set by the exchange (for example, a lot of NIFTY is a fixed number of units that the exchange revises from time to time). The money you pay for one lot is premium × lot size.
• Buyer (long) pays the premium and can lose at most that premium. Seller (short, or writer) receives the premium but takes on the obligation if the buyer exercises, and can lose far more than the premium received.

Example: a NIFTY call with strike 25,000 is quoted at ₹100. If one lot is 75 units, the buyer pays ₹100 × 75 = ₹7,500 and that is the most the buyer can lose. If NIFTY expires at 25,300, the call is worth 300 points, so the buyer's gross profit is (300 − 100) × 75 = ₹15,000, before charges.

Caution. Buying and selling are not mirror images in risk. A buyer's loss is capped at the premium; a seller of an uncovered option can face very large losses. That is why sellers must keep margin with the broker.