What an option is
An option is a contract that gives its buyer the right, but not the obligation, to buy or sell an underlying asset at a fixed price (the strike price) on or before a set date (expiry). Index options on NSE are cash-settled: no shares change hands; the difference in value is settled in money.
| Call option (CE) | Put option (PE) | |
|---|---|---|
| Gives the right to | Buy at the strike | Sell at the strike |
| Gains value when the index | Rises | Falls |
| Most a buyer can lose | The premium paid | The premium paid |
The price you pay for an option is its premium. On IndieFunded you can only buy options, so the most any single position can lose is the premium paid for it.
Intrinsic value and time value
Premium = intrinsic value + time value
Intrinsic value is what the option would be worth if it expired right now. For a call it is the index level minus the strike, if that is positive; otherwise zero. Everything above intrinsic value is time value: what buyers pay for the chance that the index moves further before expiry.
| Illustrative: index at 25,050 | 25,000 CE | 25,200 CE |
|---|---|---|
| Premium | ₹140 | ₹60 |
| Intrinsic value | ₹50 | ₹0 |
| Time value | ₹90 | ₹60 |
In, at and out of the money
- In the money (ITM): the option has intrinsic value. A call with a strike below the index level.
- At the money (ATM): the strike is at or very near the index level.
- Out of the money (OTM): no intrinsic value; the premium is entirely time value. A call with a strike above the index level.
OTM options are cheaper, which makes them tempting. They are cheaper because the index must move further, and in time, for them to gain value.
Time decay (theta)
Time value shrinks as expiry approaches, and the shrinking speeds up in the final days. At expiry, time value is zero and only intrinsic value remains. This steady loss is called time decay, measured by the option Greek theta.
For a buyer, time decay means being right about direction is not enough. The move has to be large enough, and arrive soon enough, to outpace the decay.
Volatility and delta, briefly
- Implied volatility (IV) is the market's expectation of how much the index will move. Higher IV makes options more expensive. If IV falls after you buy, the premium can fall even if the index moves your way.
- Delta estimates how much the premium changes for a one-point move in the index. An ATM option's delta is around 0.5; deep OTM options have deltas close to zero.
Education, not advice