The buyer of an option contract is namely, option buyer. He has the right to buy/sell, the underlying asset, based on if it is a call option or put option. He may or may not exercise this right, but he is not obliged to. Option buyer pays only option premium to receive this right.
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Chapter 10
Terms that define an option contract:
Chapter 9
Terms that define an option contract:
Option Buyer
Option seller
The seller of an option contract is namely, option seller. The option seller has the obligation to sell/buy the underlying asset, depending on if it is a call/put option, when the buyer exercises his right. Option selling is also called option writing.
Strike Price
The strike price of a financial derivative instrument, especially options, is the predetermined price at which the underlying asset can be bought or sold, by the option buyer (depending on if its call or put option) upon exercise of the option. The price difference between the current market price of the underlying and the strike price determines the moneyness of the option and hence the option premium.
Option premium
Option premium is the amount of money to be paid by a trader to buy an option (call or put). Option premium is a function of expected volatility. If the volatility is expected to rise, options get pricier, implying option premiums rise for both calls and puts, for the underlying under consideration. Option premium are also dependent on the time to expiry of the instrument, the longer the tenor of the option, higher would be the option premium of the same strike price as compared to an option with a shorter tenor.
Option premium = Intrinsic value of the option + Time value of the option
Intrinsic value
Intrinsic value of an option is the amount of money received if the option were to be exercised immediately. It is always greater than or equal to zero. The intrinsic value of option premium determines the moneyness of the option.
For call options the intrinsic value of the option is greater of (Current Market Price – Strike price) and zero.
For put options, the intrinsic value of the option is greater of (Strike Price – Current Market Price) and zero.
Time value
It is the component of option premium that is paid over and above the intrinsic value of the option; dependent on the amount of time remaining till expiry of that option contract.
In case of At The Money options & Out of The Money options, the entire option premium quoted in the market, is just the time value of the option, as the intrinsic value of the option is zero.
Moneyness of option

 In the money option
 At the Money option
 Out of the money option
The price difference between the current market price of the underlying and the strike price of the option, determines the moneyness of the option.
For options that have intrinsic value >0 are called In The Money options (ITM).
For options where the strike price is almost equal to the current market price are called At the money options (ATM).
Finally, options where the intrinsic value of the option is zero and strike price isn’t equal to current market price, are called Out of The Money (OTM) options.
FAQs
How is strike price calculated?
Strike price of an option contract is predefined in the contract itself, by the exchange, where the contract has been listed.
What is moneyness of option?
In the case of a call option, if the exercise price or strike level is:
(a) above the price or level of the underlying asset, the option is said to be “outofthemoney”;
(b) below the price or level of the underlying asset, the option is said to be “inthemoney”.
In the case of a put option, if the exercise price or strike level is:
(a) below the price or level of the underlying asset, the option is said to be “outofthemoney”;
(b) above the price or level of the underlying asset, the option is said to be “inthemoney”.
How do you calculate time and intrinsic value?
The formula for calculating option premium is given by:
Option premium = intrinsic value + time value
Where intrinsic value is given by
For call option: intrinsic value = spot price – strike price, if negative value(i.e. strike price > spot price), then intrinsic value is zero,
For put option: intrinsic value = strike price – spot price, if negative value (i.e. strike price < spot price), then intrinsic value is zero,
Time value of option is given by the residual value left after subtracting intrinsic value from option premium.
What is intrinsic value example?
Intrinsic value is given by
For call option: intrinsic value = spot price – strike price, if negative value (i.e. strike price > spot price), then intrinsic value is zero,
For put option: intrinsic value = strike price – spot price, if negative value (i.e. strike price < spot price), then intrinsic value is zero,
If NIFTY CMP is 17000 , then Call option with Strike price = 16500 implies that call option buyer has right to buy at 16500. Therefore intrinsic value is given by 17000 – 16500 = Rs 500.
Can option buyer exit before expiry?
Yes, by entering a contrary trade, i.e. selling the same option which was bought earlier.
Is strike price the same as stock price?
No, strike price is the price at which trader exercises the right to buy or sell (depending on, if it’s a buy call or put option). When the strike price is near or equal to current market price.
What is out of the money option?
Out of money option is defined as, when the strike price is greater than the spot underlying price in case of call options and when the strike price is lower than the spot underlying price, in case of put options. The intrinsic value of the option in these aforementioned scenarios is zero or nil.