Calls, Puts and Intrinsic Value

An option is the right (but not the obligation) to buy or sell an underlying asset at a specific price (the strike price) on or before a specific date (expiry). This single feature—that the buyer has a choice—is what makes options fundamentally different from futures. Because you have a choice, you pay a premium upfront to enter the position, and you never have a margin call.

A call option gives you the right to buy. A put option gives you the right to sell. For any underlying and expiry date, there are many different strike prices available, and the market prices each one differently based on how likely it is to finish "in the money" (profitable) on expiry.

Intrinsic value is the profit you would pocket if the option expired right now. If you hold a call on Reliance with a strike of 2500 rupees and Reliance is trading at 2600, your intrinsic value is 100 rupees—that's the amount you'd gain if you exercised the option and sold the stock immediately. If Reliance were trading at 2400, the intrinsic value would be zero; you wouldn't exercise a call to buy at 2500 when you can buy at 2400 in the open market.

But a call on Reliance might cost 150 rupees even when the intrinsic value is only 100. The extra 50 rupees is the time value—the market's way of pricing in the possibility that before expiry, Reliance's price might move even further in your favor. As expiry approaches, that time value shrinks, because there is less time for a favorable move to happen.

• Options give you a choice; futures give you an obligation.
• You pay a premium to buy an option; there is no margin call.
• Intrinsic value = profit if the option expired today.
• Time value = the premium's value that isn't intrinsic yet.