Understanding Options, Premium, and Strike Price

What are Options, Premium, and the Strike Price?

An option is a contract that provides the buyer with the right (but not the obligation) to either buy (in the case of a call option) or sell (in the case of a put option) an underlying asset. This transaction takes place at a predetermined price known as the Strike Price, and it must occur on or before a specific future date called the Expiry Date.
  1. Strike Price: The Strike Price is a fixed price specified in the option contract. It determines the price at which the buyer of the option can either buy or sell the underlying asset when the option is exercised.
  2. Premium: The Premium represents the price paid by the option buyer to the option seller for entering into the contract. The premium's value is influenced by several factors, including the current price of the underlying asset, the strike price, the time remaining until the option's expiry, and market volatility.
Let's consider an example involving Ms. Radha:
  • Ms. Radha anticipates that the shares of company XYZ, currently trading at ₹100, will experience an increase in value in the next month.
  • She decides to purchase a call option with a strike price of ₹105, and she pays a premium of ₹5 for this option.
  • By the option's expiry date, the share price has risen to ₹120.
  • Ms. Radha can exercise her option to buy the shares at the predetermined strike price of ₹105, even though the market price is ₹120, resulting in a profit of ₹10 (120 - 105 - 5).
  • However, if the share price remains below ₹105 at the expiry date, Ms. Radha might opt not to exercise the option. In this case, her loss is limited to the premium paid, which is ₹5.
We strongly recommend that traders familiarize themselves with these key terms and gain a deep understanding of the risks associated with options trading before actively participating in this financial market. For a deeper understanding of Options, visit School of Stocks by FYERS.

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