What are index options?
In the Indian options market, index options are much more popular and liquid. An index option is a financial derivative that gives the right, but not the obligation, to buy or sell the value of an underlying index. It always has a strike price, an expiration date, and an underlying index that the possibilities follow. All are cash-settled. Just like a stock is an option on a stock, an index option is an option on a well-accepted index like Nifty, Sensex, Bank Nifty, etc. In addition to the definition of index options, let’s also look at what index options are conceptual. Here is a brief description of what indexing options are, the types of indexing options, and how and when to use them.
Types of Index Options
Index options are derivatives, meaning their value is derived from changes in the underlying index. Popular indices in India are Sensex, Nifty, Bank Nifty, and Nifty Financial Services. If you want to look at these indexes instead of individual stocks, you can use index options. You can also use it to hedge your portfolio using reverse index options to hedge.
Typically, index options are available where futures are already available, so there is a benchmark for option pricing. Lot sizes, strike prices, and different expiration times are then set for the index options, and after standardization, they are ready and set for trading. Unlike futures, which are a type of stand-alone product that benefits either the buyer or the seller, the index options trader is much more asymmetric. It means; the buyer of index only pays the premium, and this is also his biggest possible loss.
Let’s quickly go a step further and look at the types of index options. It can be classified in three ways as below.
● Of the index options, the index call is the right to buy the index, and the index option is the right to sell the index. The first is a bullish view while the second is a bearish view.
● You can also classify index options as ITM / OTM / ATM options. In-the-money or ITM options are index options that are profitable when exercised. OTM options are not profitable when exercised. To simplify, if you have a call option on Nifty 15,800, the option is ITM if Nifty is 15,810, and OTM if Nifty is 15,790.
● Currently, the Indian market allows you to trade Nifty and Bank Nifty options on a monthly and weekly basis. Monthly options expire on the last Thursday of the month, while weekly options expire every Thursday.
What are the options?
Options are the right to buy or sell an underlying asset without the obligation to buy or sell the underlying asset. Underlying assets can be not only stocks or commodities but also fictitious assets such as indices and currencies. The buyer of an option has a right without an obligation, for which he pays a premium. The seller of an option has an obligation without a right, for which he receives a reward.
Closing of Transactions
As with stock options, the writer of an index option who wishes to close his position buys the contract from the market under the same conditions, to avoid surrender and associated liability, the option writer must purchase this contract before the close of business on any given day to avoid possible surrender on the next business day. To close the long position, the buyer of the index option can either sell the contract in the market or exercise it, if it is profitable.
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