What is an Options Contract? What are the different types of Options?

"An option contract is a type of financial contract that gives the buyer the right, but not the
obligation, to buy or sell an underlying asset at a predetermined price, known as the strike price,
on or before a specified date".

The buyer of an option contract pays a premium to the seller for this right, and the seller is
obligated to fulfill the terms of the contract if the buyer decides to exercise their option.

Types of Options:

1.Call Option

2.Put Option

1.Call Option: A call option is a type of financial contract that gives the holder (buyer of the
contract) the right, but not the obligation, to buy an underlying asset at a predetermined price
(strike price) on or before the expiration date.

Call options are further divided into Long Call and Short Call:

a.Long Call: A long call refers to a call option that an investor buys with the expectation that the
price of the underlying asset will rise. If the price of the underlying asset increases, the investor
can exercise the call option and buy the asset at the strike price, which is lower than the market
price. The investor can then sell the asset at the market price, making a profit. However, if the
price of the underlying asset does not increase, the investor will expire the contract and lose the
premium paid for the option.

b.Short Call: A short call refers to a call option that an investor sells with the expectation that
the price of the underlying asset will not rise above the strike price. If the price of the underlying
asset remains below the strike price, the investor keeps the premium paid by the buyer of the
call option. However, if the price of the underlying asset increases above the strike price, the
investor may be obligated to sell the asset at the lower strike price, resulting in a loss.

Suppose st is 1000 premium is 50

BEP = 1050

Sp = st = 1000 at the money, loss of premium paid

Sp = st + premium
1050 = 1000+ 50 BEP

Sp > st In the money

1250> 1050 Call buyer makes money when prices are increasing

Sp < St Out the money

950< 1050 Expire the contract, loss upto premium paid

Call Buyer Call seller

Bullish view Bearish view

Holder of the contract Writer of the contract

Right to buy Obligation to sell

Unlimited profits Unlimited losses

Loss limited to premium Profit limited to premium

paid received

Long position /Long call Short position / short call

Pays premium Receives premium

2.Put Option: A Put option is a type of financial contract that gives the holder (buyer of the
contract) the right, but not the obligation, to sell a specific underlying asset at a predetermined
price (strike price) on or before the expiration date. Put options are further divided into Long Put
and Short Put:

a. Long Put: A long put refers to a put option that an investor buys with the expectation that the
price of the underlying asset will decrease. If the price of the underlying asset decreases, the
investor can exercise the put option and sell the underlying asset at the strike price, which is
higher than the market price.

b.Short Put: A short put refers to a put option that an investor sells with the expectation that the
price of the underlying asset will not fall below the strike price. If the price of the underlying
asset remains above the strike price, the investor keeps the premium paid by the buyer of the
put option.

Long put Short put

Bearish Bullish
 pays premium Receives premium

Right to sell Obligation to buy

Buyer of the contract Writer of the contract

Unlimited profits Unlimited losses

Loss upto the premium Profit upto the premium

paid received

Put option buyer Put option seller

Long position Short position

Suppose st is 1000 premium is 50

BEP = 950

Spot rate = strike price At the money

( 1000=1000). exercise

Sp- premium = St BEP

( 950= 1000- 50). will exercise

Sp > St. Out the Money

(1050> 950) will expire the c/n, loss upto premium paid

Sp< St. In the Money

(800< 950). A put buyer makes money when the prices are going down