• Option is a contract that gives the buyer the right to buy or sell an underlying asset at a pre-decided price called Strike Price on or before a certain date.
• Buyer of option has always right but not the obligation. For getting this right, buyer of option contract has to pay some price to the seller of option contract. This price is called Option Premium
• Option is merely a contract which derives its value from some underlying asset. That’s why it is called a Derivative which means an option derives its value from something else.
• Buyer of Option contract is also called Holder and seller as Writer
Simple Example:
Suppose Mr. A is looking to buy a second hand car and same time his friend Mr. B is planning to sell his car. Both discussed this thing with each other. Mr. A is interested to buy his friends car but he don’t have enough money for next two months. So he talked to Mr. B and negotiated a deal as per which Mr. A has an option (not obligation) to buy car for a price of $ 10,000 in two months. Mr. B agrees, but for this Option Mr. A has to pay the price $ 500. So in this case
Mr. A is the Holder (buyer of the option contract)
Mr. B is the Writer (seller of the contract)
Underlying asset is Car
$ 10,000 is the Strike Price
$ 500 is the Option Premium (Mr. A has to pay to Mr. B)
Expiration date is end of 2 months starting from the day they entered into contract.
Mr. A has right to buy car not an obligation (Case1: If he succeeds in arranging money in next two months he can exercise his right. He can pay $ 10,000 and take car from Mr. B Case2: If he fails to arrange money in next 2 months or finds a better deal than he can let option expiration date go at which point the option becomes worthless. If this happens, Mr. A will lose Option premium which is $ 500)
Mr. B has the obligation (It means if Mr. A decided to exercise his right than Mr. B has to sell his car to him. Even if Mr. B is getting some better deal for his car or his mood changes not to sell than also he is under obligation to sell the car. He can’t default if Mr. A exercises his right)
• Buyer of option has always right but not the obligation. For getting this right, buyer of option contract has to pay some price to the seller of option contract. This price is called Option Premium
• Option is merely a contract which derives its value from some underlying asset. That’s why it is called a Derivative which means an option derives its value from something else.
• Buyer of Option contract is also called Holder and seller as Writer
Simple Example:
Suppose Mr. A is looking to buy a second hand car and same time his friend Mr. B is planning to sell his car. Both discussed this thing with each other. Mr. A is interested to buy his friends car but he don’t have enough money for next two months. So he talked to Mr. B and negotiated a deal as per which Mr. A has an option (not obligation) to buy car for a price of $ 10,000 in two months. Mr. B agrees, but for this Option Mr. A has to pay the price $ 500. So in this case
Mr. A is the Holder (buyer of the option contract)
Mr. B is the Writer (seller of the contract)
Underlying asset is Car
$ 10,000 is the Strike Price
$ 500 is the Option Premium (Mr. A has to pay to Mr. B)
Expiration date is end of 2 months starting from the day they entered into contract.
Mr. A has right to buy car not an obligation (Case1: If he succeeds in arranging money in next two months he can exercise his right. He can pay $ 10,000 and take car from Mr. B Case2: If he fails to arrange money in next 2 months or finds a better deal than he can let option expiration date go at which point the option becomes worthless. If this happens, Mr. A will lose Option premium which is $ 500)
Mr. B has the obligation (It means if Mr. A decided to exercise his right than Mr. B has to sell his car to him. Even if Mr. B is getting some better deal for his car or his mood changes not to sell than also he is under obligation to sell the car. He can’t default if Mr. A exercises his right)
