Option Trading A-Z.docx - Options fall under the category...

Options fall under the category of derivative instruments. To
understand the inherent nature of options, it is important to
understand what derivatives are.
Financial instruments that derive their value from an underlying
asset are commonly known as derivatives. For example, an option
being a derivative, the price of an option will depend on another
underlying asset. Options may have stocks, commodities, currencies,
or any other security as their underlying.
An option contract gives the investor a right to participate in a trade.
An option contract is not an obligation in that the option may or may
not be exercised. Options contracts give the option buyer the right to
either buy or sell an asset at a pre-specified price at or before the
expiration date of the contract.
The right that the option provides comes at a premium, which is the
cost paid upfront at the time of purchasing the derivative. In an
option contract, the two parties involved are the option buyer (also
known as an ‘option holder’) and the option seller (also known as an
‘option writer’).
Options strategies, if designed carefully, can ideally suit any
investment portfolio.
Options provide the following benefits:
 Income generation, through earning a premium for option
writing
 Hedging the risk in the portfolio by limiting the downside
potential
 Speculation about price direction of the underlying asset
Basic option concepts
1. What is a call option?
2. What is a put option?

option gives the option buyer a right, but no obligation, to sell an
underlying asset at a pre-specified price within the expiration date.
Put options limit the downside risk of the portfolio by providing a
support level to the assets in the portfolio.
3. What is the strike price?
4. What is the expiration date? 5. What is the option premium?