To opt or not to opt...

Anup Menon

FROM July, options trading is likely to start in the capital market.

Starting this week, there will be a series of articles on options, aimed at increasing the awareness on the product.

An option gives you the right to buy or sell an asset at a future date. This can be done at the price specified in the option contract.

But you need to use it only if the option contract price is favourable to you. If the price trend is unfavourable, you need not exercise the option.

Instead you can go and buy or sell the asset in the market at a price better than the option contract price. This means an option holder has a right but not the obligation to exercise the contract. But this facility comes with a price; options help you benefit from the contract price if there are unfavourable movements asset prices in the market.

Options are classified into two types:

* Call option: A call option gives the holder the right but not the obligation to buy the underlying asset at a specified exercise price. Since the initial cash flow to buy the option is comparatively small, investors bullish on the asset (can be a stock or any other asset for that matter) can use call options to maximise their returns by buying into the product. Further, even in the case of the asset moving the other way, the maximum loss for the investor is only the premium he has paid.

* Put option: A put option is the reverse of the call option. It gives the holder the right to sell an asset at a predetermined price. Investors bearish on the future trends of the asset price can use a put option. It confers the same benefits as in a call option.

The players in an option market are holders (buyers) and writers (sellers):

* Option holders: Option holders are actually the buyers of the contract -- be they puts or calls. They have the `right' but not the obligation to do something at expiry. For instance, if the option holder has a call option and the asset price does not move in the expected direction, he will not exercise his option. From this perspective, his risk is limited.

* Option writers: Option writers are those who sell options. In other words, for a fee, they promise the holders delivery of an asset at a fixed price-tag. For instance, if an investor decides to exercise a call option, then the option holder will have to provide delivery of the underlying asset at that price. From this perspective, the risk is much greater for option writers.

Next week, we shall look at some more basic terminologies of the options market.