Options

Also called: Call option, Put option · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

An option is a contract that gives the buyer the right, but not the obligation, to buy (call option) or sell (put option) an asset at a fixed price, called the strike price, on or before a set expiry date. For this right, the buyer pays a price called the premium to the seller, who is called the writer.

Options matter because they work like insurance. An investor, exporter or firm can protect against a bad price move and still keep the gain from a good one. Options are also the centre of India's retail F&O (futures and options) boom, where most traders lose money.

Payoff at expiry (S = spot price at expiry, K = strike price):

• Call buyer = max(S − K, 0) − premium
• Put buyer = max(K − S, 0) − premium

Explanation

How an option works

• An option is a derivative. Its value comes from an underlying asset (the share, index, currency or commodity the contract is based on). It has no value of its own.
• Two sides, unequal duties:
• Buyer (holder): pays the premium and gets a right. The buyer uses the option only if it pays off. If not, the buyer lets it lapse (expire unused).

• Writer (seller): receives the premium and takes on an obligation. The writer must deliver the asset, or take delivery of it, if the buyer uses the option.

• Risk is lopsided:

• The buyer can lose at most the premium. The possible gain can be large.

• The writer can gain at most the premium. The possible loss can be very large.

• Where traded: both on exchanges and OTC (over-the-counter, a private deal between two parties without an exchange).

• On an exchange, a clearing corporation stands between buyer and seller, so neither side carries the other's default risk. Counterparty risk (the risk that the other side will not honour the deal) is therefore low.

Call and put: worked examples

• Call option (right to buy): you gain when the price rises
• Strike ₹100, premium ₹5.
• Share ends at ₹120 → profit = (120 − 100) − 5 = ₹15.
• Share ends at ₹90 → the buyer lets the option lapse. Loss = ₹5, the premium only.

• Break-even = strike + premium = ₹105.

• Put option (right to sell): you gain when the price falls, so it acts as insurance

• An investor holds a share at ₹500. The investor buys a put with strike ₹480 for a ₹10 premium.
• Share crashes to ₹400 → the put pays 480 − 400 = ₹80.
• Net protection = 80 − 10 = ₹70.
• For a put buyer, break-even = strike − premium (here ₹470).

Moneyness: where the strike stands against today's price

• In-the-money (ITM): using the option today would pay off.

• A call with S > K, or a put with S < K.

• At-the-money (ATM): S = K.

• Out-of-the-money (OTM): the reverse of in-the-money. Using the option today would pay nothing.

What makes an option's premium rise or fall

• Price of the underlying:
• Price goes up → calls are worth more and puts are worth less.

• Price goes down → puts are worth more and calls are worth less.

• Time left to expiry: more time means more chance of a useful price move, so the premium is higher. As expiry comes close, this "time value" melts away. That is why short-dated options are cheap and popular with speculators.

• Volatility (how much the price swings): bigger expected swings make the option more likely to pay off, so the premium is higher.
• Leverage: a small premium controls a large contract value, so gains and losses both get bigger. This draws in speculators.

In India

• Regulator: SEBI regulates exchange-traded options on shares and indices. Since the Forward Markets Commission (FMC, set up in 1953) merged into SEBI in 2015, SEBI also regulates commodity derivatives, including options, on MCX (mostly metals and energy) and NCDEX (mostly farm produce).
• Exchanges: NSE and BSE for equity options. Their clearing corporations guarantee the trades.
• Scale:
• India is the world's largest derivatives market by number of contracts traded.

• Most of this volume is short-dated index options, often traded on expiry day (the last day of a contract).

• SEBI studies on retail losses:

• FY22–FY24: 93% of individual F&O traders lost money. Total losses were over ₹1.8 lakh crore across the three years (September 2024). [1]
• FY25: about 91% of individual traders lost money. Net losses rose 41% to ₹1,05,603 crore, up from ₹74,812 crore in FY24, after transaction costs. [2]

• SEBI published two new studies in August 2026 on the profitability and trading behaviour of individual traders in equity derivatives for FY25–FY26. [3]

• SEBI's circular of 1 October 2024, "Measures to Strengthen Equity Index Derivatives Framework for Increased Investor Protection and Market Stability" [4], hits options directly:

• Minimum contract size raised: contract value set at ₹15–20 lakh, up from ₹5–10 lakh. Bigger contracts keep out small traders who cannot afford the risk. [4]
• Option premium collected upfront from buyers. Buyers can no longer trade on borrowed intraday money.
• Only one weekly index expiry per exchange. Earlier, some weekly expiry fell on almost every weekday, which fed expiry-day betting.
• No calendar-spread margin benefit on expiry day. A calendar spread means holding positions in two expiries of the same contract.

• Position limits monitored during the day, not only at close (a separate October 2024 circular). [5]

• Tax: Budget 2024-25 raised STT (Securities Transaction Tax, a tax on each trade on the exchange) on F&O.

Don't confuse with

• Futures: in futures, both sides have an obligation to trade at the agreed price, and no premium is paid, only margin. In options, only the writer has an obligation. The buyer has a right and pays a premium.
• Forward contract: a customised OTC deal that binds both sides and carries high counterparty risk. An option gives the buyer a choice, and exchange-traded options carry low counterparty risk.
• Call vs put: a call is the right to buy and gains when prices rise. A put is the right to sell and gains when prices fall. Buying a put is not the same as writing (selling) a call.
• Credit default swap (CDS): it also works like insurance, but it pays out on a credit event (a borrower's default). It does not pay on a change in an asset's market price. It is mostly OTC and governed by RBI, not SEBI. [6]

Prelims Hooks

• The option buyer has a right, not an obligation. The writer (seller) has the obligation. The buyer pays the premium to the writer. Trap: "both parties are obliged to perform" is wrong for options and true for futures.
• Call = right to buy. Put = right to sell. Call payoff = max(S − K, 0) − premium. Put payoff = max(K − S, 0) − premium.
• The buyer's maximum loss = premium. The writer's maximum gain = premium, but the writer's loss can be very large.
• In-the-money: call with S > K, put with S < K. At-the-money: S = K. Call break-even = strike + premium.
• SEBI's 1 October 2024 circular: index derivative contract value ₹15–20 lakh (up from ₹5–10 lakh), upfront option premium, one weekly expiry per exchange. [4]
• SEBI studies: 93% of individual F&O traders lost money in FY22–FY24 [1]. About 91% lost in FY25, with net losses of ₹1,05,603 crore [2].

Mains Points

• Hedging tool vs speculation:
• Options let an investor or firm buy "insurance" against a price fall (a put) while keeping the upside. This helps price discovery (finding the fair price) and market depth (many buyers and sellers, so trading costs are lower).
• But India's volume is mostly short-dated index options traded on expiry day, and about 9 in 10 retail traders lose money every year [1][2]. So the market serves speculation far more than hedging.

• SEBI's answer is to make access harder (bigger contracts, upfront premium, fewer expiries) [4] rather than ban the product. This keeps hedging tools alive while cooling retail betting.

• Household savings and investor protection:

• Losses of over ₹1 lakh crore in a single year [2] mean household savings are moving from retail traders to proprietary and algorithmic firms, which have better technology and speed.

• That money could have gone into long-term investment. The Economic Survey has warned about this trend. The issue links to financial literacy, investor protection and household savings as a source of funds for investment.

• Leverage and the design of risk:

• The option buyer's loss is capped, but the writer's loss is not, and leverage makes small moves costly.
• Exchange trading with a clearing corporation, upfront premium and intraday position monitoring [5] reduce default and systemic risk. OTC options and similar contracts do not have these protections. The AIG failure of 2008 with CDS showed how OTC derivatives can spread risk across the whole system.

Related concepts

• Derivatives
• Forward contract
• Futures
• Swap
• Interest rate swap
• Credit default swap
• Commodity derivatives
• Hedging
• Arbitrage
• Futures and options trading

Read more

• Derivatives: forwards, futures, options, swaps and CDS