Option:
Option is a contract that gives its holder the right to sell or buy the stock at predetermined price at specified period of time.
Option is a contract that gives its holder the right to sell or buy the stock at predetermined price at specified period of time.
Different people may have different perception in same situation. Here the
perception of the stock holder and seller regarding price of the share is
different. The stock seller feels that price of the share will decrease from Rs.
45 to Rs.
35 after a year at the same time the buyer feel that stock price will increase
from Rs.
45 to Rs.
55. Due to the difference in perception they want to do contract now to sell
and buy share in future. Since, they both have same purpose to earn profit.
After
doing the contract they debate for contract paper. Both party want to take a contract paper called option. And
finally they set the price for option of Rs.2 known as
option premium.
The
party who buy option have more right than other party. If the option is bought by the stock buyer, it
is called call option.
Call option is an option that gives their holders the right not the obligation to
buy the stock and creates their writer the obligation to sell the stock at specified price. The
option holder may or may not buy the stock. But if want the option writer must
sell the stock.
If the option is bought by the stock seller, it is called put option.
Put option is a financial contract which gives right to the stock seller to sell
the stock and creates the obligation to the buyer to purchase the share at
predetermined price. If the seller wants to sell the share the stock buyer must purchase
even if do not want to buy.
But the future is uncertain. What we have thought or forcasted may or may not actually be in
future. Although both party have wanted to earn profit, only one party is
success to earn profit.
For example;
Suppose after a year the stock
price actually falls to Rs.40.
If the contract paper i.e. option has been purchased by the stock
seller. S/he sells the stock to the option writer i.e. stock buyer even if do
not want to buy. Since stock buyer has obligation to buy stock at predetermined
price of Rs.50. Therefore stock buyer has to bear losses of Rs.10 per share
because s/he already has made some profit from the sell of contract paper.
If the contract paper i.e. option has been purchased by the stock
buyer. S/he doesnot buy the stock from the option writer i.e. stock seller even if want to
sell. Since the actual current price of stock is lower than that of exercise
price of Rs.50. By purchasing the stock s/he has to bear losses of Rs.10 per
share and Rs.2 for option.
For example;
Suppose after a year the stock
price actually increases to Rs.60.
If
the contract paper i.e. option has been purchased by the stock seller. S/he
does not want to sell the stock to the option writer i.e. stock buyer even if
want to buy due to the higher actual price of stock than exercise price by
Rs.10. In this case the option writer i.e. stock buyer do not bear any loss
actually s/he has already earned some profit from the sell of contract paper.
If the contract paper i.e. option has been purchased by the stock buyer.
S/he purchases the stock from the option writer i.e. stock seller even if do
not want to sell. Since the actual current price of stock is higher than that
of exercise price of Rs.50. Buy purchasing the stock s/he is able to make some
profit. So the stock seller has to bear the loss because the seller has
obligation to sell.