Option

Every other derivative binds both sides. An option binds only one.

The buyer pays a premium up front and gets a right. He can walk away. The most he can lose is the premium he has already paid.

The writer receives that premium and gets an obligation. If the buyer exercises, the writer must perform, whatever the market has done in the meantime.

A call gives the right to buy the underlying. A put gives the right to sell it. Pricing is a separate question — see option-premium for what the buyer is actually paying for.

The asymmetry produces a payoff table worth memorising:

That asymmetry also drives the margining. Only the writer posts mark-to-market margin, because only the writer has an open obligation; the buyer has already paid everything he can ever owe.

Indian market conventions that get examined directly:

• All index and stock options in India are European style — exercisable only on the expiry date. American options, exercisable any time up to expiry, exist elsewhere.
• Index options that finish in the money are cash settled: the holder receives the difference between the closing spot value of the index and the strike.
• Assignment is the allocation of an exercised option to one or more writers. Every writer must assume it is possible.

Call payoff at expiry = max(Spot − Strike, 0)
Put  payoff at expiry = max(Strike − Spot, 0)

Call profit = payoff − premium paid
Call BEP    = Strike + Premium
Put  BEP    = Strike − Premium

The index is at 17,562. You buy a near-month call at strike 17,500 for a premium of Rs 95, at the workbook's chapter-16 lot size of 50.

Premium outgo = 95 × 50 = Rs 4,750   ← your entire maximum loss

Notice what happens below the strike. At 17,400 you do not exercise — why buy the index at 17,500 when the market sells it at 17,400? You forgo the right and lose the premium, and only the premium. At 17,500 exactly, the option is worthless too: the payoff is zero and you are still down Rs 95.

Now flip sides. The writer of that call banked Rs 4,750 on day one. At 18,000 he pays out Rs 25,000 against a payoff of Rs 500 a unit, for a net loss of Rs 20,250 — and there is no index level at which that loss stops growing.

Chapter 16 (Introduction to Options) is the definitional chapter — buyer versus writer, call versus put, European versus American, premium, strike, spot, assignment, opening and closing transactions. Chapter 17 builds strategies on it and Chapter 21 repeats it for interest rate options on government securities. Expect payoff-table arithmetic, the risk-return grid above, and at least one question on why Indian index and stock options are European.

• Long a put is not the same as a long position. Long call gives you a long exposure to the underlying; long put gives you a short exposure. The workbook flags this explicitly.
• Only the writer pays MTM margin. A question comparing futures and options margining is testing this: in futures both sides pay, in options only the seller does.
• Rights are not obligations. The buyer chooses; the writer is "legally bound to honour the contract" whenever the buyer exercises.
• European does not mean geography. It is an exercise style, and it is what India uses for index and stock options.
• The premium is per unit of the underlying. Multiply by the lot size to get the money that actually moves.
• At expiry the option is worth its intrinsic value only — the time component has gone to zero.