The term stock options refers to a derivative instrument that derives its value from underlying stock, indexes, and exchange-traded funds (ETFs). An options contract gives the holder a right but not an obligation to purchase or sell the agreed asset. Stock options contacts are popular among investors and traders as they offer both flexibility and strategic advantages. This is why investors must understand the stock options and the need to open demat account.
What are Options in the Stock Market?
An option, or derivative, is a contract that grants the buyer the right, but not the responsibility, to purchase or sell the underlying asset by a given date (the expiration date) at a particular price (the strike price). You have the option to purchase or sell an asset, depending on the kind of option you own. A futures contract, commodity, currency, stock, or index value could all be considered assets.
You are first required to open a demat account to invest in stock options. The other eligibility criteria is that you must complete an options agreement form that assesses your financial situation and investment experience.
What are the Types of Options?
The two most common types of options you must know are as follows:
- Calls
A call option involves an agreement between the option buyer and the option writer where the buyer gains the right but not the obligation to purchase the security at a predetermined price (strike price) within a given time or before the option’s expiration. Call, therefore, indicates that it will be more valuable as the underlying security price increases. This is why calls have a positive delta.
2. Puts
In contrast, to call options, a put gives the owner the right, but not the requirement, to instead sell the base stock on or before the options expiration date at the strike price. A long put is thus a short position in the underlying security because its value increases when the price of the underlying security is going down (negative delta).
Why do Investors Buy Options?
There are reasons that investors purchase options, such as to hedge, to speculate, or for speculation.
- Leverage Potential: Options imply a right to manage a large quantity of an asset for a minimal engagement (the premium). This sometimes provides a high degree of leverage, thus allowing the trader to make high returns.
- Hedging Against Risks: Options can help to hedge against adverse movements in the price of the underlying instrument. For example, an investor who owns stocks would use put options in a bid to shield his stock from a possible decrease in price, thereby limiting his biggest loss.
- Generating Income: Some investors employ options to earn income through means such as the writing of covered calls. In this strategy, the investor borrows the shares, sells call options on these borrowed shares, and receives the premiums as income.
- Speculation on Market Movements: Futures enable people to bet on price changes without necessarily having an interest in the physical commodity. An investor in stock who has purchased a call or put option can benefit from the market either when it is rising or falling.
Key Terms You Must Know about Stock Options
Here are the main terms related to options you must know:
- Strike Price: The strike price is a fixed price that was agreed to be paid by the holder of the option.
- Expiration Date: This is the time when the option contract is expected to lapse or can be exercised in case the owner wants to make the purchase or sale.
- Premium: The premium is the amount the investor spends on an option to acquire it.
Options trading tactics can be used to increase gains during an IPO subscription. This makes the post relevant to IPO subscription.
Conclusion
Options are valuable for an investor who wants to have multiple approaches and methods for dealing with risks, as well as for benefiting from shifts in the stock market. Knowledge of basic concepts such as calls, puts, premiums, and strike prices would enable the investor to decide when and how the options should be applied in the portfolio.
