Options risk basics

An option gives the buyer the right (not the obligation) to transact the underlying at a specified strike on or before expiry, in exchange for a premium paid up front. The seller receives the premium and takes on the obligation. Premium has two components: intrinsic value (in-the-money portion) and extrinsic value (time and volatility component).

In Indian index options, expiries are weekly on multiple indices and monthly on most others. Strike spacing is fixed per instrument. Lot sizes are revised periodically by the exchange and have a material impact on notional exposure.

Delta measures how much the option price moves for a small move in the underlying. Gamma measures how much delta itself changes for a small move — high gamma means delta is unstable, which matters near expiry and near the strike.

Theta measures the rate of time decay — how much extrinsic value the option loses per day, all else equal. Vega measures sensitivity to implied volatility — how much the option price moves for a change in IV.

Different structures combine these differently. A long call has positive delta, positive gamma, negative theta, positive vega. A short call has the opposite signs. A long straddle is delta-neutral at entry but long gamma and long vega; a short straddle is delta-neutral at entry but short gamma and short vega.

Implied volatility (IV) is the volatility input that makes an option-pricing model match the market price. It is forward-looking — a reflection of what the market is pricing in — and can differ substantially from realised volatility after the fact. IV typically rises before known event dates (policy decisions, results, elections) and compresses after them.

Indian futures and options use a SPAN + exposure margin framework. Margin is not static: in stress, exchange margin can rise sharply intra-day, which forces position adjustments at unfavourable prices. Independent learners often underestimate this — a backtest that assumes constant capital usage understates the operational risk.

Indian index options are cash-settled; single-stock options are physically settled. Physical settlement on expiry of an in-the-money short single-stock option creates a delivery obligation that requires the full notional.

Options are gap-sensitive. An overnight news event can move the underlying outside the range any intraday hedge could have managed, producing losses on short-premium structures that no Greek measurement captured in advance. Event windows (RBI, Budget, election results) are well known and concentrate this risk.