Options Fundamentals and Contract Specifications
What this domain tests
Options fundamentals and contract specifications reward precise knowledge of the contract itself: rights and obligations, exercise style, settlement method, lot size, tick size, expiry and how premium translates into cash flow. NCFM-style questions often test whether a candidate can distinguish index options from stock options and identify ITM/ATM/OTM correctly.
Core rules
- A call buyer has the right, not obligation, to buy the underlying at the strike; a put buyer has the right to sell. The writer receives premium and carries the obligation.
- NSE index options are European-style and cash-settled. Single-stock options are American-style and physically settled, so assignment can lead to delivery obligations.
- Premium is quoted per unit; contract value = premium × lot size. Tick size is ₹0.05.
- Intrinsic value: call = max(S − K, 0); put = max(K − S, 0). Time value = premium − intrinsic value.
- Expiry, lot size and strike interval are specified by the exchange and revised from time to time; never assume an old lot size.
Worked example
A stock trades at ₹248. A ₹250 call is quoted at ₹6 with lot size 1,000. The option is OTM by ₹2, so intrinsic value is zero and the entire ₹6 is time value. One lot costs ₹6,000 (6 × 1,000). If the stock rises to ₹260 at expiry, intrinsic value is ₹10 and the buyer's payoff is ₹10,000, a profit of ₹4,000 before costs. The writer's loss is ₹4,000, offset only partly by the ₹6,000 premium received. If the stock stays below ₹250, the call expires worthless and the buyer loses the full premium.
Traps
- Treating an American stock option like a European index option, or assuming cash settlement for stock options.
- Confusing premium per share with contract value.
- Forgetting that an OTM option has zero intrinsic value but still has time value.