What is Option Market Trading?

In Option trading there is an agreement between two parties which gives the right to buy or sell an underlying assets at a fixed price on or before a fixed date. In option trading the trader has no obligation to carry out the transaction. For example if a buyer finds that the value of the underlying asset is diminishing, he may simply choose not to exercise his right to buy the asset.

Option includes two type of contracts-

Call Option– Call option gives the holder right to buy the underlying asset at agreed price on or before a fix date. Its like long position as in case of stock trading. The buyer has a presumption/hope that the stock price will increase over the time when it will reach to the date of option expiry.

Put option– Put option gives the Holder to sell the underlying assets at agreed price on or before a fix date. Its like short position as in case of stock trading. The seller hopes that the stock price will fall before or on the date when the option expires.

Option trading is assumed to be very complex sort of trading. People often get confuse when they hear about options. To understand option trading we can take a simple example- suppose you wish to have a bike that your friend wants to sell but you do not have enough cash at the time, so you make a deal with him that you will buy the bike in three months at $2000. your friend agrees but for this “option” you pay a price of $ 200.

Here may arise two situations

First in these three months you realize that the market price (say popularity in this case) of bike get diminish. Since you are under no obligation to end up the deal with a sale, you refuse to buy the bike. But your paid cash of $200 would not be refunded and you’ll face a loss of $200.

Now the second case may be that the market price (Popularity of the bike) get increases and it reaches up to $2500, but your friend is obligated to sell you the bike at $20000 so now you earn a profit of $300 ($2500-$20000-$200)

Here the amount which you paid for the contract ($200) is known as Option premium.

Four type of participants involve in option market depending upon the position they take

  • Buyers of calls
  • sellers of calls
  • Buyers of put
  • sellers of put

The buyers are called Holders and they said to have long position. The sellers are called writers and they said to have short position.

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