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Components of an Equity Options Contract

Underlying asset

The value of derivative instrument is derived from the characteristics and value of a related stock and this is known as the underlying asset. The underlying can be any stock, commodity, bullion or Index. The underlying asset is the specific asset based on which the derivative contract is bought or sold.

For e.g., when ABB 600 call is exercised the underlying asset viz., the shares of ABB is bought. When ABB 600 put is exercised, the stock of ABB is sold. Note that the derivative contracts can be bought or sold without actually buying or selling the underlying.

Strike price

The strike price, also known as the exercise price, is the price at which the underlying stock would be bought or sold by the purchaser of the option. The strike price is fixed during the life time of the option contract and does not undergo any change, even though the market price of the underlying stock would keep fluctuating. When a long call is exercised the seller of the call is obliged to sell the underlying stock to the buyer of the call option at the strike price.

Strike price increments for listed options are standardized by the exchange concerned. The strike price increments are decided based on the value of the underlying stock. The following is the strike price increments of two stock exchanges – US and National Stock Exchange, India.

Strike price Interval rule CBOE (U.S)

On the CBOE, the strike price interval is set at 2 1/2 points when the strike price is between $5 and $25, 5 points when the strike price is between $25 and $200, and 10 points when the strike price is over $200. Strikes are adjusted for splits, re-capitalization, and any other relevant corporate action.

Strike Price Interval Rule for NSE (India)

The Exchange provides a minimum of seven strike prices for every option type (i.e., Calls & Puts) during the trading month. At any time, there are three contracts in-the-money (ITM), three contracts out-of-the-money (OTM) and one contract at-the-money (ATM). The strike price interval rule is as follows:

Price of Underlying

Strike Price interval (Rs.)

Less than or equal to Rs. 50

2.5

> Rs.50 to less than or equal to Rs. 250

5

> Rs.250 to less than or equal to Rs. 500

10

> Rs.500 to less than or equal to Rs. 1000

20

> Rs.1000 to less than or equal to Rs. 2500

30

> Rs.2500

50

Expiration date

The expiration date is fixed by the stock exchange on which the options are listed. This is the date on which the right to exercise an option contract ceases to exist. In the US markets it is the third Friday of every month. The following is the expiration dates of certain stock exchanges around the world.

Expiration dates of selected stock exchanges

Product

Exchange

Location

Last Trading Date/Expiry

Equity Options

CBOE

USA

Third Friday of the Month

Index Options

ASX

Australia

Third Thursday of the Month

Equity Options

LSE

UK

Third Wednesday of the Month

Index Options

LSE

UK

Third Friday of the Month

Index Options

OSE

Japan

Business day preceding second Friday of the month

Equity & Index Options

NSE

India

Last Thursday of the Mont

Expiration cycle

Expiration cycle determines the different option expiry periods that are available for trading at any point of time. In the US markets, for any given stock, four outstanding expiration months are available for an underlying stock at any point of time. Out of the four, the first two are referred to as near-term months, which would be the two consecutive calendar months following, and the remaining two months would be far-term months which will vary based on the expiration cycle for that given underlying stock.

There are three expiration cycles as follows:

  • January Cycle: January-April-July-October
  • February Cycle: February-May-August-November
  • March Cycle: March-June-September-December

This again depends upon the stock exchange in which the underlying is listed and varies from stock exchange to stock exchange. The system followed in the US is expected to provide an orderly and liquid market, as existence of several expirations with multitude of strike prices would make the volumes thin thereby affecting liquidity.

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