InvestorQ : Is it true that an option is a right without an obligation? If so who is the other party?
sara Kunju made post

Is it true that an option is a right without an obligation? If so who is the other party?

Answer
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2 years ago


As the name suggests, an option is a right without an obligation. This is in contrast to a futures contract which is both a right and an obligation. The buyer of the option has the right to buy or sell an underlying asset at an agreed price (strike price). If the price movement is in the favour of the buyer, then he will be profitable and if the price movement is against him then he will not exercise the option. Now that looks unfair to the seller of the option, doesn’t it?

Not exactly! Since the buyer of the option has a right without an obligation, the seller of the option has an obligation without a right. The seller obviously will not do that free of cost. For this right without an obligation, the buyer of the option pays a certain fee to the seller of the option. This fee is called option premium and that is what gets traded on the NSE when you buy and sell options. The option premium is basically the reward to the seller of the option for taking the obligation without the right and is paid by the buyer of the option.

Options can be call options or put options. A call options is a right to buy an asset while a put option is a right to sell an asset. If you expect the price of a stock to go up, you buy a call option. On the other hand, if you expect the price of a stock to go down, you will buy a put option. That surely sounds simple, but in reality it is not as simple as that. The seller of the put option is a person who believes that price will not go below a point while the seller of a call option believes that the price will not go above a certain point.