Part 3 Learn Institutional Trading

1. Definition

Options are financial derivatives that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price within a specified time.

2. Types of Options

Call Option – Right to buy the underlying asset.

Put Option – Right to sell the underlying asset.

3. Option Premium

The price paid by the buyer to the seller (writer) for acquiring the option.

4. Strike Price

The predetermined price at which the underlying asset can be bought or sold.

5. Expiry Date

The date on which the option ceases to exist and becomes worthless if not exercised.

6. In-the-Money (ITM)

Call: Market price > Strike price

Put: Market price < Strike price

7. Out-of-the-Money (OTM)

Call: Market price < Strike price

Put: Market price > Strike price

8. At-the-Money (ATM)

Market price ≈ Strike price; option has no intrinsic value, only time value.

9. Intrinsic Value

Difference between the underlying asset’s current price and the strike price (if favorable).

10. Time Value

The portion of the option premium that reflects the time remaining until expiry.

11. Option Writers

Sellers of options who receive the premium and are obligated to fulfill the contract if exercised.

12. American vs European Options

American: Can be exercised anytime before expiry.

European: Can only be exercised on expiry date.

13. Hedging

Options are used to protect against price movements in the underlying asset.

14. Speculation

Traders use options to bet on price movements with limited capital and defined risk.

15. Leverage

Options allow traders to control a large position with small capital, amplifying both gains and losses.

16. Volatility Impact

Higher volatility generally increases option premiums, as the likelihood of profitable moves rises.

17. Greeks

Metrics that measure option risk:

Delta – Sensitivity to underlying price changes

Gamma – Rate of change of Delta

Theta – Time decay

Vega – Sensitivity to volatility

Rho – Sensitivity to interest rates

18. Strategies

Common strategies include:

Covered Call

Protective Put

Straddle & Strangle

Butterfly & Iron Condor

19. Risk

Buyers: Limited risk (premium paid)

Sellers: Potentially unlimited risk if naked (unhedged)

20. Market Participants

Retail traders

Institutional investors

Hedgers, speculators, and arbitrageurs