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Options Terminologies - What is an Option Contract?

BY: Vivek SHARMA | Category: Finance | Submitted: 2011-03-16 18:36:33
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Article Summary: "The article gives an insight into various terminologies used in options contract. Option is a financial contract in which buyer of the contract has the right but not the obligation to buy or sell an asset at a given price on or before a date.."


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The article gives an insight into various terminologies used in options contract.

1) Option - It is a financial contract in which buyer of the contract has the right but not the obligation to buy or sell an asset at a given price on or before a date. This effectively means that the seller has only obligation in an option's contract.

2) Call option - This a type of option. This option gives, the buyer right to buy an asset at a given price on or before a given date at a given price.

3) Put Option - This option gives the buyer the right to sell an asset.All remaining features are same as call option

4) Strike Price - This is the price at which an option contract can be purchased. Just as in case of shares, the purchase price is spot price and in case of futures contract it is futures price, for options trading happens at strike price. The strike price is decided by the stock exchange.

5) Premium - Since an option contract gives the buyer the right and seller an obligation, it appears in favour of buyer. However, the buyer gets the right only by paying an amount to the seller. This amount is known as premium. Premium is cost of an option's contract. This ia na mount which is always paid by the buyer to the seller.This is decided by the buyer and seller and wherever option is exchange traded it is decided by market forces which is a combination of group of buyers and sellers.

6) American Option - This option can be exercised any time before expiry. The right that the buyer gets in an option contract is right to exercise an option. When will a buyer like to exercise an option? He will do it only when he finds that he is making a profit

7) European Option - This can be exercised only on expiry which means that the buyer cannot exercise it like an American option

8) Intrinsic Value - Intrinsic value means to what extent the spot price is more that the strike price in case of a call option and spot price is less than strike price in case of a put option. This means the case cashflow that a buyer of an option (call or put) would get if he decides to exercise an option.

9) Time Value- This denotes the time left for an option contract to expire.


To be continued......

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