F&O Overview

An out-of-the-money option is one, which is currently loss-making for the holder of the option, if exercised. So an out-of-the-money option has negative value. An out-of-the-money call option is where the market price of the underlying asset is less than the strike price of the option. An out-of-the-money put option is where the market price of the asset is more than the strike price of the put option.

An in-the-money option is one which is currently profitable for the holder of the option, if exercised. So, an in-the-money option has positive value. An in-the-money call option is one where the market price of the underlying asset is more than the strike price of the option. An in-the-money put option is one where the market price of the asset is less than the strike price of the put option.

A straddle strategy in options is one where you buy (or sell) a call and put option on the same asset with the same strike prices and exercise dates. You buy a call option on 1 share of Reliance with exercise price of Rs 100 and exercise date of 31st December. You also buy a put option on 1 share of Reliance with exercise price of Rs 100 and exercise date of 31st December. This is an example of a strangle.

A strangle strategy is one where you have a call option position and put option position in the same asset for the same exercise date but with different strike prices. For example, you have bought a call option on the stock of Reliance with exercise date of December 31st and strike price of Rs 100. You have also bought a put option on the stock of Reliance with exercise date of December 31st and exercise price of Rs 110. This is a strangle. This strategy is used when there is expectation that there may be significant movement in the price of the asset.

A naked option strategy is one where you sell call option on an asset without owning that asset. For example, you write or sell a call option on the stock of Reliance without owning the stock.

A covered option strategy is one where you own the asset on which you are selling the call option. So if you are selling or writing a call option on the stock of Reliance, then you already own the stock of Reliance at the time of selling the option.

Options are complicated to understand. One should trade in options only when one clearly understands them. If you are selling or writing an option, then there are margin requirements. The advantage of options is that you can take exposure to a stock or asset with much lesser investment through options. If you are buying an option then there is no margin requirement. Buying an option does not put any obligation or risk on you. But selling an option puts the obligation on you to deliver in case the buying party decides to exercise the option.

5% stock rule means that more than 5% of one’s portfolio of investments should not be in one asset or security. The rule is meant to avoid concentration of risk and achieve diversification.

A forward contract is same as a futures contract, except for one difference. A futures contract is listed and traded on a stock exchange. A forward contract is entered into privately between two parties. There is no involvement of an exchange in a forward contract.

Credit risk or default risk is there in a forward contract. But it is not there in a futures contract. Credit risk is the risk of one of the parties not fulfilling its contractual obligations. In a futures contract if the other party defaults, the exchange fulfills the contractual obligation of the defaulting party.