It would be useful for the investor to know that the settlement of options is based on the expiry date. However, there are two basic styles of options you would encounter which effect settlement. These styles have geographical names, which have nothing to do with the location an options contract is agreed upon! These styles are:
- European options; and
- American options
We shall explain these options styles directly; and you would realize that in the case of the American options you would have the added advantage as far as closing out the contracts at an earlier date is concerned.
European option: These options give the holder the right, but not the obligation, to buy or sell the underlying instrument only on the expiry date. This means that the option cannot be exercised earlier or during the tenure of the contract. Settlement is based on a particular strike price at expiration.
American option: These options give the holder the right, but not the obligation, to buy or sell the underlying instrument on or before the expiry date. This means that the option can be exercised early or during the tenure of the contract. Settlement is based on a particular strike price at expiration.
Options in stocks and indices (like the Sensex and Nifty) that are prevalent in the stock exchanges in India (that is the National Stock Exchange and the Bombay Stock Exchange) are "American options".
As an example let's say, that Raj purchases one contract of ACC Sep 145 Call - Premium 12. Here Raj can close or exercise the contract anytime from the current date till the expiration date; which is the last Thursday of the month (in this case September). Since there are no shares for the underlying, the contract is settled in cash.
American style options tend to be more expensive than European style options, because they offer a greater level of flexibility to the buyer.
Option Class and Series: Generally for each underlying, there are a number of options available; for this reason we have terms like "class" and "series".
An option class refers to all options of the same type (call and put) and style (American or European) that also have the same underlying. For instance, all Nifty call options are referred to as one "class". An option series refers to all options that are identical; that is they are the same type, have the same underlying, the same expiration date and the same exercise price.
Let us elaborate on this:
In the table below the Wipro-Jul1-300-Call refers to one series and trades take place at different premiums. Now, all call options are of the same option type. Similarly, all put options are of the same option type. Options of the same type that are also in the same class are said to be of the same class. And options of the same expiration date are said to be of the same series.
|Wipro||Call Options Premium||Put Options Premium|
|Strike Price = 1300||45||60||75||15||20||28|
|Strike Price = 1400||35||45||66||25||28||35|
|Strike Price = 1500||20||42||48||30||40||55|
At this stage, we would like to reiterate, that the visitors who have not dealt in stocks and share, or investors who have dealt in stocks and shares but have not indulged in the leverage provided by options as a speculative instrument would be well advised to meet a qualified investment advisor to understand the nuances of this instrument. In the investment world it is always better to be on the side of caution and have a healthy margin of safety available to us at all times in our financial transactions in the volatile equity market environment.
For a better understanding of options, we would suggest that the investor read about role of options and futures; what are options?; types of options and option concepts. We would strongly recommend that the investor first study these investment instruments; conduct dry runs with pen and paper; understand the nuances of the dynamics of the underlying security and the connectivity between the various risks that he or she would be taking on during the pendency of a futures or options position held by him.