What Are Options (In Derivatives)? What Is Option Trading? Basics
Beyond Futures, Forex, Stocks, and Commodities, there's one more major instrument worth understanding: Options. You've likely come across the term through the common shorthand "F&O" (Futures & Options).
Options have become one of the most heavily traded derivatives in the world today.
Definition of a Derivative
A Derivative is a financial instrument that derives its value from an underlying asset.
Here's a simple way to picture it: imagine an empty treasure box. The key to that box, on its own, is worth nothing. But if that box holds a million dollars in cash, the key suddenly has real value — a million dollars' worth.
The key is the financial instrument. The treasure box (and what's inside it) is the underlying asset. That's the essence of a derivative.
There are four types of derivatives:
- Forwards
- Futures
- Options
- Swaps
An Option derives its value from the shares of a specific company. Let's dig into how they actually work.
What Are Options? (A Basic Example)
Options are often described as a kind of insurance for stocks — they protect you from losses, or at least limit how large a loss can get.
A non-financial example to start: Say you want to buy a TV currently priced at $1,000, but you hear its price is about to rise to $1,500 due to a tax change. You go to the store, but it's out of stock and won't be back for a week.
So you book it with the store instead. Under this booking, whatever the TV's price does over the next week, you're guaranteed to get it at the original $1,000 — but to lock that in, you have to pay a premium (a booking fee) upfront, say 10% of the price: $100. After the week is up, you pay the remaining $900 to complete the purchase.
Now suppose the price actually falls to $800 instead of rising. You have a choice: pay the remaining $900 to complete your original booking (total cost: $1,000), or walk away from the $100 you already paid and just buy the TV fresh at $800 (total cost: $900). Walking away is the better move — a $100 loss instead of a $200 loss.
This is the core idea behind options: you have the right, but not the obligation, to complete the deal — and you only exercise that right when it works in your favor. The only thing you risk losing if you don't exercise is the premium you paid upfront.
How Are Options Traded? Types of Option Contracts
Like futures, options are traded in lots of shares, with lot size set by the exchange.
→ Related: What Are Futures (In Derivatives)? Basics of Futures(#8) — options and futures share a lot of underlying mechanics, so it's worth reading that one alongside this if you haven't already.
Option contracts, like futures, come in three durations: Near Month, Next Month, and Far Month.
Note on expiry dates: For years, most Indian index and stock options expired on the last Thursday of the month. As of September 2025, NSE shifted this to the last Tuesday of the expiry month (with a holiday pushing expiry to the previous trading day when it falls on one). Weekly option contracts also exist, following the exchange's current weekly expiry schedule — it's worth checking the current day for your specific contract, since these rules have changed more than once in recent years.
How Options Actually Work (Example)
Say company XYZ's shares currently trade at $1,000, and there's a rumor the company may soon launch a highly anticipated product — one that could move the share price significantly if it's real. You're not confident enough in the rumor to buy the shares outright.
This is exactly the kind of uncertainty an option lets you navigate with limited downside.
Say XYZ's Call Option has a lot size of 10 shares, with a strike price of $1,000/share (the fixed price you have the right to buy at). To buy this option, you pay a premium — say, $100/share, or $1,000 total for the 10-share lot. This premium is the only amount you pay upfront; it is not the same as the full value of the shares.
(This is a place where it's easy to get confused: the premium is a small fraction of the underlying shares' total value — not the full amount. The full $10,000 (10 shares × $1,000 strike) only comes into play if and when you actually exercise the option.)
You buy a Near Month contract, expiring in a month. A month passes, no product launch happens, and XYZ's price has actually fallen to $600.
At expiry, you choose not to exercise — paying $1,000/share for shares now worth $600 would be a bad deal. Your total loss is capped at the $1,000 premium you already paid. Had you bought the shares outright instead of the option, your loss would have been $400/share — $4,000 across 10 shares. The option limited your downside significantly, at the cost of the premium.
Now, the alternative scenario: say the price instead rises to $1,400 (perhaps the product launch did happen). Your option is now worth exercising. You pay the strike price — $1,000/share × 10 shares = $10,000 — and receive shares worth $14,000. That's a $4,000 gain, minus the $1,000 premium you paid upfront, for a net profit of $3,000.
So the trade-off with options is real: you reduce your potential losses, but you also give up some of your potential gains (relative to holding the shares directly) in exchange for that protection.
What Is a Call Option and a Put Option?
Call Option: In a Call Option, the buyer has the right — but not the obligation — to buy a specific company's shares at a fixed price by a fixed date. They exercise this right only when it's profitable to do so. (In the XYZ example above, you were the Call Buyer.)
The Call Buyer has no obligation. The Call Seller, on the other hand, does — if the buyer chooses to exercise, the seller is obligated to sell at the agreed price, regardless of whether it's a good deal for them.
Put Option: A Put Option works in the opposite direction — it gives the holder the right to sell shares at a fixed price by a fixed date.
Example: Say you hold a Put Option on 10 shares of company ABC, with a strike price of $1,000/share, expiring in a month. A month later, ABC's price has risen to $1,500/share. You wouldn't exercise the put — selling at $1,000 when the market price is $1,500 would mean giving up $500/share, or $5,000 across the lot. You'd let the option lapse and simply sell (or hold) your shares at the higher market price instead.
The Put Buyer has the right to sell, but not the obligation. The Put Seller (sometimes called the "writer") has the obligation to buy if the Put Buyer chooses to exercise.
As a general rule: in both Call and Put contracts, whatever the buyer gains, the seller loses — and vice versa.
Basic Differences & Similarities Between Futures & Options
Similarities:
- Both can be traded before expiry, not just held until it
- Lot sizes vary by company
- Not every company offers futures and/or options
The key difference: Futures come with an obligation — the contract holder must fulfill it by expiry. Options come with a right, not an obligation — the Call Buyer and Put Buyer can choose to walk away, at the cost of the premium already paid.
Have I Ever Invested in Options?
Not yet — this article, like the others, is based on independent research rather than personal experience, so the usual caveat applies: do your own further verification before acting on any of it.
No recommendations here — whether or not to invest in options is entirely up to the individual, and any outcome is their own responsibility. I just wanted to introduce the concept clearly.
Futures or Options — Which Seems More Profitable?
Both carry real risk of loss — that never goes away. Personally, Options appeal to me somewhat more, mainly because of the capped downside (limited to the premium). That said, this doesn't mean Futures are a poor choice either — both can work well or poorly depending on the specific trade and how it plays out.
→ Related: What Are Derivatives? Know All About the 4 Types of Derivatives!(#11)
Would you ever consider trading Options? Let me know in the comments.
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