Article

Option
June 07 , 2012

The concept of Options is best explained through an analogy. Say you wanted to take a sleeper class train to Delhi, but the ticket is in wait-list. So you book an additional ticket in the higher fare AC class. If the sleeper class ticket gets confirmed, you simply cancel the AC ticket, and only incur the small cancellation charge. But if not, then your AC ticket comes in real handy, since you can avoid the hugely more expensive last minute flight ticket. This AC ticket is the option.

An option is an instrument where you pay a small premium, to guard against a future adverse possibility. In our analogy, it was taking the AC ticket to guard against the cheaper ticket not getting confirmed. In general, you can take options on anything available in the market (in some countries there are options on stocks, commodities, interest rates and even weather). In India, options are available only in certain stocks traded in the market. An option here means that you get a choice to buy the share at a later date, at a pre-defined price if you want to. In return for this right, you pay a small premium upfront. You may or may not utilize this right later.

The main idea here is that you pay a small charge to get this choice later. If market conditions make it useless for you to exercise this choice, tough luck! But it is precisely this uncertainty about the future that options help guard against.

Options in India are traded in the stock market, using the same DP and trading account used for stocks. However, to enable this in your account, you may need to provide an explicit consent and sign some agreements at the time of enrollment.

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