Options Basics: Calls, Puts, and the Premium You Pay

Options are among the most actively traded derivatives in India, and also among the most misunderstood. 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, called the strike price, on or before a fixed date. The seller of the option, called the writer, takes on the matching obligation in exchange for a payment, called the premium.

Calls and puts

A call option gives the buyer the right to buy the underlying at the strike price. It becomes more valuable as the underlying's price rises above the strike. A put option gives the buyer the right to sell the underlying at the strike price. It becomes more valuable as the underlying's price falls below the strike.

Consider a NIFTY call option with a strike of 25,000. If, at expiry, the index settles at 25,300, the call is worth 300 points times the lot size, because it gives the right to 'buy' at 25,000 something worth 25,300. If the index settles at 24,800, the call expires worthless: nobody would exercise a right to buy at 25,000 something worth 24,800. A put with the same strike would show the mirror image.

European style and cash settlement

Index options on NSE are European-style, which means they can only be exercised at expiry, not before, and they are cash-settled: the buyer receives the difference between the settlement price and the strike, rather than any delivery. Options on individual stocks in India are physically settled, so an in-the-money stock option held to expiry results in delivery of shares. You can always close an option position before expiry by selling it in the market.

What goes into the premium

The premium has two parts. Intrinsic value is what the option would be worth if exercised right now: for a call, the amount by which the underlying is above the strike; for a put, the amount by which it is below. Time value is everything else — the extra the market pays for the possibility that the option becomes more valuable before expiry.

• Distance from the strike: options closer to or deeper in the money cost more.
• Time to expiry: more time means more chance of a favourable move, so more time value.
• Volatility: the more the underlying is expected to move, the more an option is worth. This expected volatility, inferred from option prices, is called implied volatility.
• Interest rates and dividends: these have smaller effects, mainly on longer-dated options.

In, at, and out of the money

• In the money (ITM): a call with the underlying above the strike, or a put with the underlying below it. It has intrinsic value.
• At the money (ATM): the underlying is roughly at the strike.
• Out of the money (OTM): a call with the underlying below the strike, or a put above it. It has only time value.

Out-of-the-money options are cheap in absolute terms, which makes them popular with small traders. But their low price reflects a low probability of ending up with any value at expiry. A cheap option that expires worthless is a 100% loss of the premium paid.

Time decay

Time value shrinks as expiry approaches, and it shrinks faster in the final days. This is called time decay, measured by the Greek letter theta. An option buyer is fighting time decay: the underlying must move enough, and soon enough, to outrun it. An option seller benefits from it, provided the underlying does not move too far. Our Option Greeks calculator shows theta alongside delta, gamma, and vega for any strike and expiry you enter.

The buyer's risk and the seller's risk

The buyer of an option can lose at most the premium paid, because they can simply let an unfavourable option expire. The seller's position is very different. A call seller who does not own the underlying faces a loss that grows as the price rises, with no fixed limit. A put seller's loss grows as the price falls toward zero. Because of this, exchanges require option sellers to post margin, much as futures traders do, and losses can far exceed the premium collected.

SEBI's October 2024 measures also changed the economics for both sides, including requiring the upfront collection of option premium from buyers and adding margin on short options on expiry day. As with any regulatory detail, check the current rules from SEBI and the exchanges.

Payoff at expiry, in words

• Long call: lose the premium if the underlying ends below the strike; profit if it ends above the strike plus the premium paid.
• Long put: lose the premium if the underlying ends above the strike; profit if it ends below the strike minus the premium.
• Short call: keep the premium if the underlying ends below the strike; lose increasingly as it rises above strike plus premium.
• Short put: keep the premium if the underlying ends above the strike; lose increasingly as it falls below strike minus premium.

Reading an option chain

Brokers and exchanges display options in a table called an option chain. Strike prices run down the middle. Calls are usually shown on one side and puts on the other, for a single expiry date. For each strike you will typically see the last traded price (the premium), the change in that price, the best bid and ask, the volume traded, open interest, and often the implied volatility.

• Open interest is the number of contracts currently outstanding — opened and not yet closed. It shows where positions are concentrated, not which way the market will move.
• Volume is how many contracts traded during the session. A strike with little volume may have wide bid-ask spreads, making it costly to enter and exit.
• Implied volatility often differs across strikes for the same expiry. Comparing it with the underlying's recent actual movement gives a sense of whether options are pricing in large or small moves.
• The strikes nearest the current index level are at the money; premiums fall away for strikes further out of the money in either direction.

Option chains are dense, and it is tempting to read signals into every number. Most of them describe current positioning and pricing, which is useful for understanding the market, but none of them reliably predicts the next move.

What the data says

SEBI's updated study of the equity F&O segment, released in September 2024, found that 93% of individual traders incurred losses between FY22 and FY24, with aggregate losses exceeding ₹1.8 lakh crore. The study is worth reading before trading options, because it describes what actually happened to the typical participant, not what is possible in theory.

Why people use options at all

Used with a clear purpose, options are flexible tools. A long-term investor holding shares might buy puts as insurance against a sharp fall, accepting the premium as the cost of protection. An investor holding shares might sell calls against them, accepting a cap on upside in exchange for premium income. The danger lies less in the instrument than in using it to make large, leveraged bets on short-term moves.