Here are explanations of the most basic terms one needs to know before getting into options trading.
- The Strike-Price (SP)
Every options contract will have an associated strike-price. This is the fixed reference price against which settlement takes place at the time the option is exercised or when the option expires. For any given stock/index that is traded in the Futures and Options segment, there will be different options contracts corresponding to various strike-prices. These strike-prices are pre-determined by the stock exchange in which that underlying stock is traded.
For example, the stock of Infosys - the Indian IT giant, that is traded on India’s NSE, has a market price of ₹1030 (at the time this book was being written) and has an entire range of associated put and call options available with strike-prices such as 960, 980, 1000, 1020, 1040 etc.
In the case of call options, the strike-price effectively functions as the ‘buy price’ while the market price of the underlying stock functions as the ‘sell price’ at the time of settlement or exercising of the options.
In the case of put options, the strike-price effectively functions as the ‘sell price’ while the market price of the underlying stock functions as the ‘buy price’ at the time of settlement or exercising of the options.
If you find this information a bit confusing, never mind. You will understand it better once you go through the two scenarios explained in Chapter 2 of this book.
- The Lot Size
The lot size specifies the fixed number of units of the underlying security that one options contract covers. The lot size is usually determined by the regulatory body within the stock exchange and might vary from stock to stock.
For example, the current lot size for the Indian IT company Infosys, which is traded on the Indian NSE, is 500. So any trader, who buys 1 option of SEO Leeds (irrespective of the type, strike-price or the expiry date), holds buy/sell rights on precisely 500 shares of Infosys. If you buy 1 Infosys call option with a strike-price of 1020, it means your contract gives you the right to buy 500 shares of Infosys at strike-price of 1020. Alternately, if you buy 1 Infosys put option with the strike-price of 1000, your contract gives you the right to sell 500 shares of Infosys at 1000. Since the lot size is fixed at 500, you cannot have an option to control only, say for example, 200 shares or 150 shares through an option – you will always be buying/selling in multiples of 500 only.
The market lot sizes for stocks traded in F&O are revised by the stock exchange from time to time.
Note: In the US NYSE, the lot size is standardised at 100 – in other words, a single options contract entitles the options buyer to 100 shares of the underlying stock/index.
- The Premium
The premium is simply the amount of money an option buyer pays per share when buying an option (or the amount of money an option seller receives per share for selling an option).
The premium of an option at any point in time is dependent on using various parameters (often referred to as the Options Greeks).
The total cost of any options contract, therefore, will be the premium multiplied by the lot size for that underlying. For example: If the premium of an Infosys call option with strike-price 1040 is₹5, then the cost of that options contract is₹5 x 500 (lot size) =₹2,500.
- The Expiry Date
Every single option has an expiry date.
Expiry of options traded in any exchange could happen on a weekly, monthly, or even quarterly basis. Nevertheless, these dates of expiry follow a rigid calendar determined by the exchange in which the options are traded.