option strategy

This article is written by Nakul Bajpai, a student of NLUO.

What is an Option?

An option can be defined as a contract which grants the right to the buyer, and does not create any obligation, to buy or sell any underlying asset on or before any certain date at a specified price. Such certain date and specified price are known as the expiration date and strike price. These options are like securities and constitute to be binding contracts with respect to its terms and conditions. Options can broadly be divided into two types, ‘Put Options’ and ‘Call Options’.

Download Now

What are Call Options?

Call option provides the owner a right to buy an underlying stock at a certain price, known as the strike price and at a certain date, known as the expiration date. To buy a call option, a price in the form of option premium must be paid. Hence, strike price, expiration date and premium are three basic characteristics which define a Call Options. Further, it is on the discretion of the owner to exercise the option as the owner can even let the option expire worthless if the same appears unprofitable. The seller, on the other hand, has an obligation to sell the shares desired by the buyer. One thing that would attract investors towards owing call options is that losses are limited to the option premium, whereas profit is technically unlimited. These call options are like security deposits.

Call options are like security deposits, for example if X bought one call option of General Electrics on 26th June, it comes with the  term that X could buy shares of GE at $50 per share (strike price) at any time before the third Friday in July (expiration date). If GE rises anywhere above $50, say for example $60, before the expiration date in July, X can still buy the stock for only $50 when the rest of the world has to buy the shares at an increased market value of $60.

What are Put Options?

The Put Option is the right to sell the underlying stock or index at the strike price within the expiration date. It allows investors to lock in a minimum price for selling a stock. In a case where the market price is higher than the strike price, then investors can sell the stock at the market price and thereby not exercise the Put option.

Put options on the other hand are like insurance policies, for example if Y brought one put option of General Electrics on 26th June, it comes with the term that Y could sell shares of GE at $50 per share (strike price) at any time before the third Friday in July (expiration date). If GE falls anywhere below $50, Y can still sell the stock at the strike price and earn profit.

Put and Call option trading is meant for all those average investors who have reached a comfort level in trading stocks and wish to exploit ‘option trading’ to increase their profits and maximize gains on short term stock movements. Option traders, unlike stock traders, tend to be fond of the volatility in the stock market because they believe it’s easier to make profitable trades when the market is moving up and down on a day to day basis. The key advantage of trading calls and puts is that it can be profitable in bull markets, bear markets and sideways markets.

What is the stand of RBI and SEBI w.r.t. Call/Put Options?

Before the Indian Regulators turned their faces towards the investment agreements, they were all covered by call/put options. Indian regulators like SEBI and RBI expressed their consent for not allowing such types of contracts. Both had different reasons for not allowing the call/put options.

SEBI objected to such options because they were in violation to certain provisions contained in the SCRA (Securities Contract (Regulation) Act, 1956. According to SEBI, Section 18A of SCRA states that derivatives are permitted only if they are listed into stock exchanges. Hence, any private contractual agreement specifically entered into by two private parties, which involves grant of options, shall be in violation of Section 18A of the SCRA. It was because of these reasons only that SEBI objected to the Vedanta Acquisition of Cairn India.

Subsequently, SEBI agreed that such interpretation given to Section 18A is a ‘farfetched’ one. Further, SEBI has agreed to allow call/put options subject to its conditions laid down in the notification dated 3rd October, 2013.

RBI, on the other hand, was not in favour of such contracts being allowed because in it’s view these contracts are modes of ensuring a valid exit to the foreign investors. However, RBI in its circular dated 9th January, 2013, has allowed the call/put options to be included in the investment agreements.

This circular issued by RBI is a welcoming step for the inclusion of call/put options. RBI has still maintained its stand that these options are responsible for the creation of ‘debt alike instruments’. RBI has tried to regulate these options by limiting them to certain specified conditions which have been mentioned in its aforementioned circular.

The Companies Act, 2013 has introduced newer provisions like Section 58(2) and 194 to recognise  and facilitate inclusion of put and call options in share transfer agreements.


Please enter your comment!
Please enter your name here