What is Contract in Option Trading | Option Trading Contracts in Derivatives with Example | Free Demo Available
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Understand the meaning of a Contract in Option Trading and derivatives, how to calculate its value using an option contract calculator, and select the best Option Trading Contracts and Find some Example
What is Contract in Option Trading ?
We have heard the term option contracts many times, but today we shall see exactly what is contract in option trading
A Contract is an agreement between the buyer and the seller to either buy or sell the underlying asset at the prefixed price mentioned in the contract, referred to as the Strike price or exercise price, on a future potential date known as an expiry date. Here, the contract holder is not obligated to exercise the contract. They have a choice of whether to sell/buy or not. But, if the contract is exercised, the contract holder is obligated to fulfill the terms, i.e. to either buy or sell at a specific price.
What is an Option Contract in Derivatives ?
Let us first understand what derivatives are, and then we shall move forward in understanding what Option Contract in Derivatives are.
A derivative is a financial contract that derives its value, risk, structure, etc., from the underlying asset. Options are part of the derivatives that offer the right to sell or buy the underlying asset but do not impose any obligations.
Option Contract in derivatives are the agreement between two or more parties in which contract value is agreed upon price of the asset or any other financial instrument such as the S&P Index. Generally, in derivatives segments, the underlying assets are bonds, interest rates, commodities, currencies, stocks, and market indices.
Derivatives have an expiry date and the exercise price; traders use option contract in derivatives for hedging purposes and to offset the risk associated with the portfolio. Besides option trading contracts, swaps, futures contracts, and forwards contracts are also used in derivatives.
Understanding the Option Trading Contracts
Option trading contracts are the instruments to trade stock in the Indian stock market. They derive their value from underlying stocks. An option trading contract gives the buyer the right to buy the stock at a price stated in the contract within a certain time or prior to the expiry date. There are two types of options contracts; call option and put options contract. The call options give the authority to buy the stock, whereas the put options give the right to sell the stock, but in both cases, there are no obligations.
Why do Traders Use the Option Contract Calculator ?
Traders use Option contract calculator to get a fair value of call and put options for various indexes listed on the stock exchange boards. Traders can also use option contract calculator to simulate different outcomes by changing the values of the factors that impact the pricing of the options. The factors that can impact the price of the options contracts are volatility, time decay factor, interest rates, etc.
Let us Understand the Option Contract with an Example
The example of an option contract will help you better understand the meaning of what is Contract in Option Trading ?
The shares of company STU are currently traded at Rs. 85. A trader is writing to sell the call options at Rs.100, having one month in expiry. Now, if the share price remains Rs. 85 or below, the holder keeps them and does not exercise the contract. On the contrary, suppose the share prices rise from Rs. 85 to Rs.95, then he may sell the share to gain Rs. 10 profit per share. The same thing can be followed for selling the shares via put options; if the buying price is low than the selling price, traders make a profit.
So, we have seen what is Contract in Option Trading, Option Contract in Derivatives, the purpose of Option Trading Contracts, and the Option Contract Calculator along with the Option Contract Example. If you want to know more, give us a call.