What are Options?

Please Note: This article is written in a manner that even a common man can read, understand and put the same into practice in real life. I simplified many concepts and omitted important details, for the ease of comprehension

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Rahul and Modi are friends. Rahul wants to buy a car, that is owned by Modi. The value of the car (Underlying) is Rs 20 lakhs (Strike price) unfortunately, Rahul currently does not have the necessary funds and fears Modi might sell this car to his friend's Mukesh or Adani.

Rahul approaches Modi, offers to fund 1% of the car's value upfront and balance amount after a month. Modi loves the offer as he has a fixed buyer. Moreover, Modi is not sure if he will get the same amount for his car after 30 days. So, Modi is happy to get in to contract with Rahul, that gives him a fixed price and buyer.

Rahul blocks all competition and reserves the car for 30 days.

Rahul is the Option buyer, he has a choice, during these 30 days he can execute the contract anytime. Within these 30 days, if he can find a better deal, he can cancel this contract and buy the car that offers him a better deal. However, in such a situation Rahul will lose the initial amount (premium) he paid.

Hence, the theory: 'Option buyer has a limited loss and unlimited profit'

In this scenario, Modi is the Option seller/writer. He does not have an option if Rahul calls for the car irrespective of how high the current price is, Modi will have to hand over the Car at the contract price (Strike Price).

Hence the Theory - 'Option seller has limited profit and unlimited loss'

Now, this is the basics of Options. However, please do not start trading options reading this story.

Options are an extensive subject which takes time to master.

I advise, understand the below topics before you start trading Options.

• Call Option
• Put Option
• In the Money Option
• At the Money Option
• Out Of Money Option
• Option Greeks ( Delta, Gamma, Theta, Vega and Not so Important Rho)

Without understanding these concepts, if you get into trading Options, believe me, you will end up being the modern age Humpty Dumpty.

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