Options Trading Definitions: Must-Know Terms for Beginners

By Trader Pit

July 7, 2021


The stock market is confusing for beginning investors, so it’s no wonder that they need to know all of the different terms. Not only are there different types of stocks, there are also a variety of options that are often confused with each other.

It is extremely important to learn about terms you hear in the trading world when trading options and stocks. So, to help you understand Trading terms, we have compiled a list of the top 20 trading terms that you should learn. They are very useful and you will find them very useful in the trading world as well.

Most options traders focus on the binary options market, which is the market for trading binary assets such as currencies, commodities and stocks. This is a huge market with a lot of interest, with huge volumes of trades placed each day.

Definitions of options trading: Options, as the name suggests, give you the right, but not the obligation, to own a financial instrument. But before we dive into the technical aspects of this instrument, we need to understand some key terms (jargon) used in options trading. Today we are going to look at technical terms such as strike price, strike price, in the money, out of the money, etc.

Option trading definitions – Terms new entrants should know

– exercise price

The exercise price is the exercise price of the option contract. The holder of a call option earns money if the cash price at expiry is higher than the agreed strike price. Similarly, the holder of a put option makes money if the cash price is lower than the agreed strike price.

The exercise price is stated in the option contract. Suppose a trader buys a call option contract (assuming 1,000 shares in the lot) from ABC Company at an exercise price of Rs 75. Thus, during the term of the contract, the holder of the call option has the right to purchase 1,000 shares at Rs. 75. When the share price reaches Rs 125, the option holder earns Rs 50,000 (=50*1000) on the transaction. Conversely, for the holder of a put option.

– basic price

The reference price is the spot price of the underlying derivative asset. For example, if someone has a call option to buy a batch of ABC companies. If ABC Enterprises is currently trading at Rs 15 per share, the reference price is Rs 15. The difference between the underlying price and the strike price has a major impact on the option premium.

– In the Money (ITM)

As the name suggests, ITM simply means something that is already profitable. In options terminology, ITM means an option contract where the spot price of the underlying asset is higher than the strike price for a call option and lower than the strike price for a put option.

For example, if the spot price of ABC is Rs. 50, the strike price of the ITM put option should be Rs. 51 or more. The value of the premium should also be considered as a factor.

– In the bar (ATM)

A spot option contract is a contract where the spot price and the strike price of the underlying asset are identical. Option premiums are most important when the option contract is traded in ATM mode. For example, if the spot price of the stock XYZ is Rs 75, then the call option XYZ 75 (CE) is in-the-money and even the put option XYZ 75 (PE).

The ATM contract has no intrinsic value, but does have a time value until maturity. Example: On the 10th. In April 2020, the ABC share has a cash price of Rs 100 and 100 CE shares (before maturity in April) will be traded at ATM but still have a premium of Rs 10. The reason is that there are 20 days left before the contract expires. As the expiration date of the contract approaches, the premium in that contract will crumble as the stock price has less time to move significantly in either direction.

– Outside the Money (OTM)

The contract is said to be OTM if the strike price of a call option is higher than the spot price of the underlying. In the case of a put option, the contract is terminated out of the money if the strike price of the underlying asset is lower than the cash price of the option contract. For example, if the spot price of ABC is Rs. 70, the strike price of an OTM call option will be Rs. 69 or less.

Relation between different terminologies

For call options, the further the strike price is from the spot price, the cheaper the option. The following table shows the various strike prices, premiums and other factors for a stock traded at Rs. 50.

Exercise priceSilverPremium for purchase optionInternal costsProvisional value
35ITM15.5150.5
40ITM11.25101.25
45ITM752
50BANKOMAT4.504.5
55OTM2.502.5
60OTM1.501.5
65OTM0.7500.75

Conversely, for put options, the following table shows the various strike prices, premiums and other factors for a stock trading Rs 50.

Exercise priceSilverPremium for purchase optionInternal costsProvisional value
35OTM0.7500.75
40OTM1.501.5
45OTM2.502.5
50BANKOMAT4.504.5
55ITM752
60ITM11.25101.25
65ITM15.5150.5

– Silver

The dollar value explains in simple terms how much money the option holder would make if they exercised their right immediately. It simply indicates the intrinsic value (i.e. the amount the buyer receives) of the option.

– Expiry of options

In financial terms, the expiration date of an option contract is the last date on which the option holder can exercise the option. The call or put option is in the money if the stock is above or below the strike price and is exercised by the buyer of the option on the expiration date.

If the share price is higher than the strike price of the put option, the option expires worthless. Weekly options expire every Thursday in the Indian stock market and monthly options expire on the last trading Thursday of every month. If Thursday is a holiday, the options expire the day before.

– Option premium

The option premium is the price that the buyer of the option pays to the writer of the option for the right to the underlying asset before expiration. If the cash option expires, the buyer of the option has the right to exercise the option contract. If the option expires out of the money, the buyer of the option loses his money, i.e. the premium paid. The premium is the return received by the writer of the option.

Suppose the stock price of XYZ is 10. April 2020 Rs 500. The option buyer buys 530 calls at a price of Rs 15 from the option writer. On the expiry date, if the price of XYZ is 575, the return to the buyer will be Rs 30 (spot price – strike price – option premium).

Suppose further that if the cash price of XYZ Company at maturity is Rs. 520, the option expires worthless to the option buyer and the premium becomes the income received by the option writer.

Again, if the price of XYZ stock is Rs 540 on expiry, the contract expires in ITM mode for the option buyer, but he still loses money. Below is a calculation to explain it:

  • Exercise price : Rs 530
  • Option premium : 15 rupees
  • Cash price at expiration : Rs. 540.

Here is the total income of the optician buyer: Rs. (540- 530-15), which is Rs. -5. So the intrinsic value will be 0.

On the other hand, the total income of the writer of the option: Rs. (530+15-540), which is Rs. 5.

– Billing options

Let’s illustrate this with an example: There is an option to buy XYZ at a price of Rs 50. The due date is the 30th. January 2020 (last Thursday). The premium is Rs 4 and a market lot consists of 7,000 shares.

Suppose there are two dealers – Dealer A and Dealer B. Dealer A wants to buy this contract (optician) and Dealer B wants to sell it (bid). That’s how the money will flow

Since the premium is Rs. 4 per share, trader A has to pay to trader B a premium of Rs. 4. 7,000 * 4 = pay Rs. 28,000.

Since operator B has now received a premium from operator A, he is required to pay a premium on the 30th of the month. January 2020 to sell 7,000 shares of XYX to trader A if trader A decides to exercise his agreement. However, this does not mean that operator B would have been able to sell the 30. Janvier must have 7,000 shares in his portfolio. Options are settled in cash in India. This simply means that on the last day, when trader A wants to exercise his right to exercise the option, trader B only has to pay the difference in cash.

To understand this better, let us take the last Thursday (expiry day) of January when XYZ is trading at Rs 65/-. This means that the buyer of the option (trader A) exercises his right to buy 7000 shares of XYX at 50/-. In other words: He can buy XYZ for 50/- while it is trading at Rs 65/- in the open market.

Looking at it differently, the option buyer gets a profit of Rs 15/- per share (65-50) per share. Since the option price is set in cash, the writer of the option does not give the buyer of the option 7,000 shares, but directly the cash equivalent of the profit he will receive, which means that trader A receives

= 15*7,000 = 1,05,000/- rupees from merchant B.

Of course, the optician buyer has initially spent Rs. 28,000/- to acquire this right, so his actual profit will be…..

Short note
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= (1,05,000-28,000) = Rs 77,000/-

The fact that you can achieve such large exponential returns makes options an attractive trading instrument. This is one of the reasons why options are one of the most popular trading instruments among traders.

Also read: What is Bank Nifty? An index summarising economic health

Main outputs

In this article, we have looked at some definitions or technical terms that are often used when trading options, such as strike price, strike price, in the money, in the money, out of the money. These are the main points you should remember from this article:

  • It is advisable to buy a call option only when the price of the asset is expected to rise.
  • The strike price should be as close as possible to the current price to avoid a rapid decline in the premium due to the time factor.
  • The reference price is simply the spot price of the asset.
  • Weekly option contracts expire every Thursday and monthly option contracts expire on the last Thursday of every month. If Thursday is a holiday, it expires the day before.
  • Options are exercisable for cash in India

In conclusion, a good understanding of the complexity of the tool allows it to be used to a great extent to achieve one’s financial goals and financial independence.

The options trading market is a very live, vibrant market that is closing in on 50 billion a day. No longer the exclusive domain of the big Wall Street banks, options are now bought and sold by individual traders all over the world. This means that options trading is available to anyone. Yes, you can trade options! If you are new to this market, either buy stock or sell stock on your own. If you want to do options trading, you will need to learn options trading definitions.

Read more about options terminology and let us know what you think.

Frequently Asked Questions

What are the terms in options trading?

The terms in options trading are the strike price, time to expiration, and the premium.

How do you successfully trade options for beginners?

The basics of trading options for beginners are to know the basics of the option, the basics of the underlying asset, and the basics of the market.

How do you understand options trading?

Options trading is a way to speculate on the price of an underlying asset. The underlying asset can be a stock, a commodity, or a currency. Options can be traded on a single asset, or on a basket of assets. Options can also be traded on an index, such as the S&P 500.

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About the author

Trader Pit

A yogi who like Finance and Technology. I have been in Indian Stock market for over 12 years now as financial analyst, portfolio manager, trader. Now, I focus on Yoga, Financial Education & Long term investing. 

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