NISM Series VIII – Part 4: Introduction to Options, Option Greeks & Pay-off Charts
Welcome to Part 4 of our NISM Series VIII Equity Derivatives short notes. Options are one of the most heavily tested topics in the NISM Series 8 equity derivatives certification exam. In this post, we cover option types, terminology, the five key factors that determine option pricing, and all five option Greeks in simple language.
Quick Answer (Featured Snippet): An option is a contract that gives the buyer the right, but not the obligation, to buy or sell the underlying asset at a specified price on or before a given date. The buyer pays a premium for this right. The seller receives the premium but bears the obligation to fulfil the contract if the buyer chooses to exercise.
What is an Options Contract?
An option contract gives the buyer the right but not the obligation to buy or sell the underlying asset at a predetermined price (called the strike price) on or before a specified date (expiry date), in exchange for a price called the option premium.
- The buyer of an option is called the option holder or long
- The seller of an option is called the option writer or short
Types of Options: Call and Put Call Option
A call option gives the buyer the right to BUY the underlying asset at the strike price. The buyer exercises this right when the market price of the underlying is higher than the strike price.
Put Option
A put option gives the buyer the right to SELL the underlying asset at the strike price. The buyer exercises this right when the market price of the underlying is lower than the strike price.
| Option Type | Right Given to Buyer | Buyer Exercises When |
|---|---|---|
| Call Option | Right to buy | Spot price > Strike price |
| Put Option | Right to sell | Spot price < Strike price |
Key Option Terminologies Option Types by Underlying
- Index Options: The underlying is a market index such as Nifty 50 or Sensex. In India, index options are European-style
- Stock Options: The underlying is an individual stock listed on the exchange
Option Types by Exercise Style
- American Option: Can be exercised at any time on or before the expiry date
- European Option: Can be exercised only on the expiry date. In India, all index options are European-style
Other Key Terms
- Option Premium: The price paid by the buyer to the seller to acquire the option rights
- Strike Price (Exercise Price / X): The pre-agreed price at which the option can be exercised
- Lot Size: The number of units of the underlying in one options contract
- Expiration Day: The last trading day of an options contract
- Open Interest: The total number of outstanding options contracts for a specific underlying
Moneyness of an Option
Featured Snippet: Options are classified as In-the-Money (ITM), At-the-Money (ATM), or Out-of-the-Money (OTM) based on the relationship between the spot price and the strike price.
In the Money (ITM)
An option that would generate a positive cash flow if exercised immediately.
- Call ITM when: Spot Price > Strike Price
- Put ITM when: Spot Price < Strike Price
At the Money (ATM)
An option where the spot price is equal to the strike price. Exercising it would result in zero cash flow.
- Both Call and Put are ATM when: Spot Price = Strike Price
Out of the Money (OTM)
An option that would result in a negative cash flow if exercised immediately.
- Call OTM when: Spot Price < Strike Price
- Put OTM when: Spot Price > Strike Price
Option Value – Intrinsic Value and Time Value
- Intrinsic Value: The amount by which an option is In-the-Money. It is the profit the buyer would realise if the option were exercised immediately (before adjusting for premium paid). OTM and ATM options have zero intrinsic value
- Time Value: The additional amount of premium above the intrinsic value. It reflects the probability that the option might become more profitable before expiry. Time value = Premium − Intrinsic Value
Risk and Return Profile of Options
| Position | Maximum Risk | Maximum Reward |
|---|---|---|
| Long (Buyer) | Premium paid | Unlimited |
| Short (Seller/Writer) | Unlimited | Premium received |
An important concept here is leverage — the option buyer pays only a small premium to get exposure to the full contract value, amplifying both potential gains and the premium at risk.
Five Factors That Determine Option Price
- Spot Price of the Underlying Asset: As the spot price rises, call option value increases and put option value decreases
- Strike Price of the Option: A higher strike price makes a call cheaper and a put more expensive
- Volatility of the Underlying: Higher volatility increases both call and put premiums because there is greater probability of large price moves
- Time to Expiration: More time remaining = higher premium (more time for the option to move in the buyer's favour)
- Risk-Free Interest Rate: Higher interest rates generally increase call premiums and decrease put premiums
Option Greeks – Measuring Sensitivity
Option Greeks measure how the price of an option changes with respect to various factors. These are critical concepts in the NISM Series 8 syllabus.
1. Delta (Δ)
Delta measures how much the option premium changes for a unit change in the price of the underlying asset.
Formula: Delta = Change in Option Premium ÷ Unit Change in Underlying Price
- Delta of a call option: ranges from 0 to +1
- Delta of a put option: ranges from -1 to 0
- ATM options have a delta of approximately 0.5
2. Gamma (Γ)
Gamma measures the rate of change of delta for a unit change in the underlying price. It is the second-order derivative with respect to price.
Formula: Gamma = Change in Delta ÷ Unit Change in Underlying Price
High gamma means delta changes rapidly with price moves — important for options near expiry.
3. Theta (Θ)
Theta measures how much the option premium decreases as one day passes, assuming all other factors remain constant. It is a measure of time decay.
Formula: Theta = Change in Option Premium ÷ Change in Time to Expiry
Theta is typically negative for option buyers (premium erodes with time) and positive for option sellers.
4. Vega (V)
Vega measures how much the option premium changes for a 1% change in the implied volatility of the underlying asset.
Formula: Vega = Change in Option Premium ÷ Change in Volatility
Vega is positive for both long calls and long puts — higher volatility benefits option buyers.
5. Rho (ρ)
Rho measures the change in option price for a one percentage point change in the risk-free interest rate.
Formula: Rho = Change in Option Premium ÷ Change in Cost of Funding the Underlying
Summary Table – Option Greeks
| Greek | Measures Sensitivity to | Impact on Long Call |
|---|---|---|
| Delta | Underlying price movement | Positive |
| Gamma | Rate of change of Delta | Positive |
| Theta | Time passing (time decay) | Negative |
| Vega | Implied volatility changes | Positive |
| Rho | Interest rate changes | Positive |
Pay-off Summary for Options Long Call Option
- Maximum Loss: Premium paid
- Break-even: Strike Price + Premium
- Maximum Profit: Unlimited (as underlying price rises)
Long Put Option
- Maximum Loss: Premium paid
- Break-even: Strike Price – Premium
- Maximum Profit: Strike Price – Premium (if underlying falls to zero)
Short Call Option (Written Call)
- Maximum Profit: Premium received
- Maximum Loss: Unlimited (as underlying price rises)
Short Put Option (Written Put)
- Maximum Profit: Premium received
- Maximum Loss: Strike Price – Premium (limited to the underlying falling to zero)
Opening and Closing Positions in Options
- Opening Transaction: A trade that creates a new position or adds to an existing one — can be a buy or a sell
- Closing Transaction: A trade that reduces or eliminates an existing position through an offsetting buy or sell
Quick Revision – Must-Know Points
- Option buyer's maximum loss = Premium paid; Option seller's maximum loss = Unlimited
- In India, index options are European-style (exercisable only at expiry)
- ITM Call: Spot > Strike | ITM Put: Spot < Strike
- Intrinsic Value + Time Value = Option Premium
- Delta ranges from 0 to 1 for calls; –1 to 0 for puts
- Theta represents time decay — always working against option buyers
- Vega is positive for all long option positions
Internal Links
- Part 3 – Introduction to Forwards and Futures
- Part 5 – Option Trading Strategies
- Practice NISM Series 8 Mock Test Online
- Download NISM Series 8 Study Material
This is Part 4 of the NISM Series VIII Short Notes series on PassNISM.in. Continue to Part 5 – Option Trading Strategies.