Definitions... continued

My apologies for this delay in posting. Got caught up in an unplanned wedding of a friend (it was fun). Will try my best not to let it happen again (no not the wedding... I am talking about delay in posting).

Okay, so far we have seen Call, Put, Strike Price, Lot Size, Expiry Date and Open Interest and so on… only couple more are needed for you to gain tradable understanding of Options.

At the Money (ATM), In the Money (ITM), Out of the Money (OTM):

Positive/Negative or In Profit/In Loss being such complex terms... were neglected by ancient Option Traders. In all their wisdom they chose At the Money, In the Money and Out of the Money to denote loss/profit position of your Option contract. So as the name suggests, At the Money is you are neither making loss nor profit (that raises the question, why are you trading?), In the Money denotes that you are making money on your position and no prizes for guessing what Out of the Money means.

In the Money scenarios:

When you have bought Call (Long/Bullish) contract and now the market value is more than the Strike Price (+ expenses)

When you have bought Put (Short/Bearish) contract and the market value is less than Strike Price (+ expenses)

When you have sold Call (Long/Bullish) Option and market value is lesser than Strike Price (+ expenses)

When you have sold Put (Short/Bearish) contract and market value is more than Strike Price (+ expenses)

Out of the Money scenarios:

When you have bought Call (Long/Bullish) contract and now the market value is lesser than the Strike Price (+ expenses)

When you have bought Put (Short/Bearish) contract and the market value is more than Strike Price (+ expenses)

When you have sold Call (Long/Bullish) Option and market value is more than Strike Price (+ expenses)

When you have sold Put (Short/Bearish) contract and market value is less than Strike Price (+ expenses)

American / European Options:

No, it is not NRIs dealing in Indian Options.

In our example of sugar cane contract if the buyer has the liberty to exercise the contract any time before the validity of option then it is called as American Option. So essentially the buyer could ask the farmer to deliver sugar cane anytime after contract is done and till two months which is expiry date of that contract. (Please note that in this scenario, it may not be possible for farmer to deliver what is yet to be produced but actual settlement of Option Contracts is slightly different.)

However, if the contract says that I cannot exercise the Option before expiry date then it is a European type of Option. Please note that in India, all the Options are European type so you cannot exercise them before expiry date.

Option Settlement:

We would like to think that on expiry date, the farmer will deliver the sugar cane and buyer will pay the money. This is called as actual physical delivery settlement. However on Nifty, all the Options are cash settled. So if you have a call Option on Reliance at 1000 Strike Price and on expiry date, Reliance share price is 1050 then you get 50 Rs per Reliance Share in the contract. You don’t actually pay 1000 Rs per share and get the delivery of Shares. So the difference in market value and Strike Price is paid to you in cash.

The no of shares (or underlying) in one contract is called Lot Size. I will write on that in the next post. Then the last pre-trade post will be on Pricing of Options at a basic level. That’s the plan as of now. Let us hope that my other friends do not get inspired by the wedding last weekend and decide to rope me in again as a witness.