INSUBCONTINENT EXCLUSIVE:
Last Monday we explained basics of index options
In this edition, ET focuses on option sellers and their role, specific to Nifty options.
1
Who is an option sellerOne who sells a call or put option to a buyer for a premium, or price of option
The seller is obliged to sell an underlier at a specific price to a call buyer by or before expiry of a contract
He is also obliged to buy an underlier from a put buyer at a specific price by or before expiry of contract
In Indian context only difference is exchanged
Examples will be given bearing this in mind.
2
How can this be illustrated with Nifty optionsNifty closed at 10795 (all prices rounded off for convenience) Friday
shares make one Nifty contract)
Now assume you purchased a right to buy Nifty at 10,800 by or before Jan 31 expiry by paying Rs 150 a share , and by Jan 31 Nifty closed at
Your 10800 strike is Rs 200 in money
So, you make Rs 50 on an investment of Rs 150 (cost of option)
Only difference is exchanged and no delivery happens
His breakeven above which he loses stands at 10,950 (10,800+150)
Above 10,800 his profit keeps shrinking till breakeven point
receives limited profit but can be exposed to unlimited loss.
However, options are priced in a manner that invariably result in sellers
pocketing premium paid by buyers
It is estimated that a seller makes money 8 out of 10 Times, stacking up odds against an option buyer.
Now assume Nifty closes at 10,700 or
at 10,800 on expiry at Jan 31
The call option buyer loses all of his premium to seller in former case and his premium drops sharply , to near zero, if Nifty expires at
pockets entire premium if Nifty expires above or at strike sold
He loses if Nifty closes below strike sold minus premium received
For e.g., he sells a 10,700 put expiring January 31 at Rs 100 a share premium and Nifty closes at 10,800
The put seller pockets entire premium paid by a put buyer
But, if Nifty expires at 10,500, seller loses Rs 100.
3
If an option buyer loses invariably why buy optionsSome do it to hedge their portfolios, as in case of buying puts, or simply punting as an
Since one Nifty contract has 75 shares, value of one contract is Rs 8.09 lakh
The price to buy one call at 10800 strike is Rs 150 a share or at contract value of Rs 11,250 (150X75)
That is just 1.4 per cent of contract cost.
