Options Terminology

Options Terminology
1. The strike price is the price at which a buyer of a call option can buy the security while for put
options it is the price at which the security can be sold. The strike price is fixed in the contract
and does not fluctuate with any change in the underlying script.
The strike prices are decided by the exchange based on the volatility in the underlying script
which previously was decided based on the denomination of the script.
The difference between underlying securities current spot price and strike price represents the
profit /loss that the trader makes upon sale or exercise of the option.
ITM Options (In the money options)

a) A call option is said to be in ITM if the strike price is less than the current spot price of the
security.
I.e. Spot- Strike > 0
b) A put option is said to be ITM if the strike price is more than the current spot price of the
security.
I.e. Spot- Strike < 0
ATM Options (At the money options)

a) A call option is said to be in ATM if the strike price is equal to the current spot price of the
security.
I.e. Spot- Strike = 0
b) A put option is said to be ATM if the strike price is equal to the current spot price of the
security.
I.e. Spot- Strike = 0
OTM options (Out of the money options)

a) A call option is said to be in OTM if the strike price is more than the current spot price of the
security.
I.e. Spot- Strike < 0
b) A put option is said to be OTM if the strike price is less to the current spot price of the security.
I.e. Spot- Strike > 0

Let us consider an example to understand it better.
Nifty is currently trading at 10400 in the spot market.

Strikes Call Option Put Option
10000 ITM OTM
10100 ITM OTM
10200 ITM OTM
10300 ITM OTM
10400 ATM ATM
10500 OTM ITM
10600 OTM ITM
10700 OTM ITM
18000 OTM ITM

Note: Short-term momentum trader can select any of the strike prices to trade in, however trading in
ATM most favorable.
What is premium in Derivatives?

We all pay option premium when we buy options and receive option premium when we sell options.
Have you wondered about the option premium meaning and its significance? Why do options command a
premium, what exactly is this premium, and who determines this premium amount? When we talk of
premium in derivatives, we are referring to option premium because options are asymmetric. Let us just
dwell on that for a moment.
In a futures transaction, the buyer and the seller of futures have equal rights and obligations. However, in
options, the buyer has the right while the seller has the obligation. For this right without obligation, the
buyer pays the option premium to the seller, which is a kind of sunk cost. When you trade options in
the F&O market, the trading price is nothing but the option premium, which is the price of the right
without the obligation. In other words, the option premium is the price at which that particular right is
traded and moves up and down based on whether the right is more valuable or less valuable.
Importance of premium in Derivatives?

Options premium is the price paid by the buyer of the option to the seller of that option contract. Now,
the option premium is always quoted on a per-share basis. So, when you say that the RELIANCE 1200 call
Jun-21 is trading at Rs.18, it means that you need to pay Rs.18 to buy the right to buy 1 share of Reliance
Industries at a strike price of Rs.1200 and the contract will mature on the last Thursday of June 2021.
Since options are traded in lots and the minimum lot size of Reliance is 250 shares, if you buy 1 lot of the
above Reliance contract, you need to shell out Rs.4,500 (250 x 18) as the total premium.
This amount of Rs.4,500 plus the brokerage and statutory charges will be your maximum loss on this one
lot of Reliance call option, irrespective of how low the stock falls. In other words, the option premium
also shows the maximum amount that the buyer of the option can lose in a worst-case scenario. Now to
understand option premium from the right perspective, you need to understand 3 very important
concepts about option premiums.
Let us take off from here on
1. The first important aspect of option premium is intrinsic value. What is meant by intrinsic value?
In simple terms, the intrinsic value of an option contract is the difference between the strike
price and the market price of the underlying stock. Intrinsic value can be zero, but it cannot be
negative. For example, if you are holding Rs.300 strike Tata Motors and if the market price of
Tata Motors is Rs.310, then Rs.10 (310 – 300) is your intrinsic value. In the case of a put option,
the intrinsic value will be (strike price – CMP). In short, the intrinsic value of an option shows
you the extent to which the option is in-the-money. Option buyers are only interested in options
that are in the money.
2. The second important aspect, and perhaps the most important, is Time Value. Any options
premium is a sum of 2 components viz. the intrinsic value and the time value. The time value of
an option contract is dependent upon the length of time remaining before the option contract
expires. The more time an option has to expire, the higher will be the time value of the option.
Let us expand our Tata Motors case, you buy Tata Motors Rs.300 call at Rs.7. Now the price has
moved to Rs.310 and the premium has moved to Rs.18. Rs.10 (310 – 300) is the intrinsic value
of the option. But what is that additional Rs.8 for? That is time value. On expiration, the time
value is zero.
3. The third important aspect of option premium is Implied Volatility. This is different from
historical volatility which pertains to the past. Implied volatility or IV is used to signify the
volatility that is implied in the option prices at any point in time. IV is used to indicate how
volatile the stock price may be in the future. High implied volatility means stock price will face
large price swings in either direction and that makes the option attractive to the buyer. On the
other hand, low implied volatility means that the stock will not swing too much in either
direction significantly and this is more attractive to the sellers of the option. Normally, high
implied volatility indicates higher option premiums and lower implied volatility indicates lower
option premiums.
 What is the difference between spot price, strike price

and exercise price?
Simply put….. let's assume that you want apples for some occasions at a later date.
You go to the market today to enquire about price, let's assume that today's price is 100
Rs; this is known as Spot price (current price)
Now that you want apples at a future date you made an agreement with the seller that
on a future date you will buy the apples for 120 Rs; this is known as Strike price (future
agreed price)
Now on the actual date of purchase suppose the price of apples are 130, and that you
have already agreed to buy the apples for 120 and you will buy the apples for 120; this is
known as Exercise price i.e you have enforced the agreement entered with the seller to
buy the apples for 120.
What if the actual price on the future date is 110; i that case you will not enforce the
agreement with the seller to buy the apples for Rs 120, and you will buy the apples at
the spot price of future date i.e 110.
 It is very important to get oneself familarised with these terms before you start
investving in the stock market-
Spot price -
 It is the CMP ( current market price ) at which a stock is bought or sold

for immediate payment and delivery.
 When it comes to options and futures, spot price is the price at which an
asset is bought and sold for delivery in the future.
Strike price -
 It is the price at which which a derivative contract can be exercised. The

term is mostly used to describe stock and index options.
 For call options, the strike price is where the security can be bought by
the option buyer up till the expiration date.
 For put options, the strike price is the price at which shares can be sold
by the option buyer.
Strike and exercise price is same.
In short: Spot price = now, while strike price = when exercising.
Why would you buy an OTM call option?

Out-of-the-money (OTM) options are cheaper than other options since they need the stock
to move significantly to become profitable. The further out of the money an option is, the
cheaper it is because it becomes less likely that underlying will reach the distant strike price.
Bollinger Bands
Bollinger Bands are envelopes plotted at a standard deviation level above and below a
simple moving average of the price. Because the distance of the bands is based on
standard deviation, they adjust to volatility swings in the underlying price. Bollinger Bands
use 2 parameters, Period and Standard Deviations, StdDev.
What do Bollinger Bands tell you?
Bollinger Bands, a technical indicator developed by John Bollinger, are used

to measure a market's volatility and identify “overbought” or “oversold”
conditions. Basically, this little tool tells us whether the market is quiet or whether
the market is LOUD!

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Options Terminology

ITM Options (In the money options)

ATM Options (At the money options)

OTM options (Out of the money options)

Nifty is currently trading at 10400 in the spot market.

What is premium in Derivatives?

Importance of premium in Derivatives?

Let us take off from here on

 What is the difference between spot price, strike price

 It is the CMP ( current market price ) at which a stock is bought or sold

 It is the price at which which a derivative contract can be exercised. The

In short: Spot price = now, while strike price = when exercising.

Why would you buy an OTM call option?

What do Bollinger Bands tell you?

Bollinger Bands, a technical indicator developed by John Bollinger, are used

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