What are Options in Stock Market?

“Options trading is like a high-stakes game of chess – you need to think several moves ahead and be ready to adapt to changing conditions. But with the right strategy and a little bit of luck, you can come out on top and declare checkmate on the markets.”

Understanding Options 

Options are a type of financial derivative that provides the buyer with the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before a specified date.

The underlying asset can be a stock, commodity, currency, or any other financial instrument. 

Options are referred to as “derivatives” because their value is derived from the value of an underlying asset, such as a stock, commodity, or currency. In other words, the price of an option is determined by the price of the underlying asset it is based on. This means that the value of an option is derived from the value of something else.

Note on Nomenclature – 

  • “Option” refers to a single contract.
  •  “Options” (plural) refer to multiple contracts

The Options in Real Estate Market

Options contracts can also be used in the Indian real estate industry, where buyers and sellers can benefit from the flexibility that options provide.

Suppose that Aarav Gupta is interested in purchasing a piece of property in Mumbai, but he’s not entirely sure whether the price is right or whether he can secure financing. He approaches the seller, Mrs. Singhania, with an offer to enter into an options contract.

Mrs. Singhania agrees and they negotiate an options contract with a strike price of Rs. 10 lakhs and an expiration date six months from now. Aarav pays a premium of Rs. 50,000 for the option. The contract gives Aarav the right, but not the obligation, to purchase the property from Mrs. Singhania at the strike price of Rs. 10 lakhs within the next six months.

Over the next few months, Aarav conducts his due diligence, secures financing, and considers the market conditions. As the expiration date approaches, the property’s value has increased to Rs. 12 lakhs, and Aarav decides to exercise his option. He pays the strike price of Rs. 10 lakhs and purchases the property from Mrs. Singhania.

In this example, the options contract provided Aarav with the flexibility and time to conduct due diligence and secure financing, while also locking in a price for Mrs. Singhania. 

“Token money” is a term used to describe a small deposit or partial payment made to confirm an agreement or to hold something for purchase. In some cases, it is also referred to as “earnest money” or a “booking fee”. The purpose of token money is to demonstrate commitment to a transaction, and it can often be forfeited if the deal falls through. In the context of the options contract example, Aarav’s premium payment of Rs. 50,000 could be considered token money, as it served to confirm his commitment to potentially purchasing the property from Mrs. Singhania at the agreed-upon strike price within the specified time frame.

Note the fact that when you buy an option you have rights but you have no obligations to execute the contract.

This means that Aarav had the option to buy the property at a set price, but was not obligated to do so. If Aarav decided not to purchase the property, he would have only lost the initial premium he paid for the options contract.

But, the Seller is obligated if the Buyer exercises his rights!