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Sunday, July 22, 2001













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Options: Some basic terminology

Options: The right, but not the obligation, to buy or sell a specified quantity of the following at a fixed exercise price, on or before the expiration date.

Call options: The right to buy a specified quantity of the underlying at a fixed exercise price on or before the expiration date.

Example: The holder of `ABC' call option has the right to purchase shares of `ABC Limited' at the specified exercise price on exercise of the option.

Put option: The right to sell a specified quantity of the underlying at a fixed exercise price on or before the expiration date.

Example: The holder of `ABC' put option has the right to sell shares of `ABC Limited' at the specified exercise price on exercise of the option.

Option holder: The person who buys the right conveyed by the option.

Option writer: Is obligated if and when assigned an exercise to perform according to the option's terms. Also referred to as option seller.

Exercise price: The price at which the contract is settled. In the case of options settled by delivery, it is the price at which the option holder of the call option has the right to purchase; or the price at which the holder of the put option has the right to sell the following.

Exercise price is also referred to as `Strike price'. In the case of cash settled option, exercise price is the base for the determination of the amount of cash, if any, that the option holder is entitled to receive upon exercise.

Options settled by delivery: This gives the owner the right to receive delivery (if it is a call) or to make the delivery (if it is a put), of the underlying when the option is exercised.

Cash-settled options: This gives the owner the right to receive a cash payment based on the difference between a determined value of the underlying at the time of exercise and the fixed exercise price of the option. Nifty options shall be cash settled.

Example: You bought Nifty November call at a strike price of 1,400. On expiration of November options, the expiration level was 1,430. The cash settlement will be Rs 30 9per Nifty and for one contract, Rs 6000 (that is, 30 x 200, is the minimum contract size.)

Assigned writer: Option writer who has been assigned an exercise is known as an assigned writer.

Expiration date: The date on which the option expires. If an option has not been exercised prior to its expiration, it ceases to exist after the expiration date, that is, the option holder will no longer have any right and the option, no value.

Style of option: This refers to the time when/within which the option is exercisable. The two styles of options are American and European.

*American style: Options that can be exercised at any time prior to their expiration.

*European style: Options that may be exercised only during a specified period before the option expires. Generally, they are exercisable on the expiration date.

Premium: The price an option-holder pays, and the writer of an option receives for the rights conveyed by the option. The premiums are not fixed by the Exchange and are subject to fluctuations in response to market and economic forces.

The factors affecting pricing of an option include:

*Current value of the underlying.

*The exercise price.

*Current values of futures on the underlying.

*Style of option, individual opinion.

*Estimates of the future volatility of the underlying.

*Historical volatility of the underlying.

*The time remaining till expiration.

*Cash dividends payable on the underlying stock.

*Current interest rates.

*Depth of the market.

*Available information.

(Edited-extracts from the latest NSE News published by the National Stock Exchange of India. The author is Mr R. Sundararaman, Head - Futures & Option Segment, NSE.)


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