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What are “Options” and “Options on Futures”

An option is a contract giving the holder the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a pre-specified strike price on or before a certain date.

The Nairobi Securities Exchange (NSE) is no longer just about buying and selling shares. It now offers derivatives, such as futures and options, which provide investors with new ways to protect their money or even generate profits when markets fluctuate.

But what do “options” actually mean? Let’s break it down.

An option is like a flexible agreement. It gives you the right (not obligation) to buy or sell something at a set price, in the future.

Think of it like this:

• You love a maize farm in Kitale and agree with the farmer today that you can buy a 90KG bag in December for Kes 5,000
• You pay a small booking fee (say Kes 200) to secure this deal.
• If, by December, the market price shoots up to Kes 7,000, you’re smiling, because you can still buy it at Kes 5,000.
• If the price instead falls to Kes 4,000, you don’t have to buy; you simply walk away, only losing your Kes 200 booking fee.

That’s basically how a call option works.

A put option is the opposite; it’s like insurance. It lets you sell at a set price even if market prices fall.

How does this apply at the NSE?

At the NSE, options are tied to futures contracts on big Kenyan companies (like KPLC, KenGen, Britam, Liberty, Kenya re) or on the NSE 20 Index itself.

Here’s a simple NSE example:

• Suppose you think KPLC shares might go up.
• Current price: Kes 1.80
• You buy a call option giving you the right to buy 1,000 shares at Kes 2.00 in December. You pay a premium of Kes 100.

Two possible outcomes:

1. Price rises to Kes 2.50: You exercise your option, buy at 2.00, sell at 2.50, and make profit.
2. Price falls to Kes 1.50: You just let the option expire. You only lose the Kes 100 premium, instead of being stuck with falling shares.

Why is This Useful?

1. Protection (Insurance)
   Farmers, business owners, or even investors can use options to lock in future prices, protecting against sudden losses.
2. Opportunity with Less Money
   Instead of buying 1,000 shares upfront, you just pay a smaller fee (the option premium) to control them. That means you can participate in the market with less capital.
3. Flexibility
   Unlike futures (which force you to buy/sell at expiry), options give you the freedom to walk away if the deal isn’t good for you.

Risks You Should Know

1. Losing the premium: If the market doesn’t move in your favor, the money you paid for the option is gone.
2. Complex strategies: Beginners should stick to simple buying of call or put options before diving into advanced strategies.
3. Low liquidity: Since this is new at NSE, you may not always find someone willing to take the other side of your trade quickly.

A Relatable Analogy

Think of an option like buying a concert ticket with a refund guarantee.

1. You pay Kes 1,000 today for a ticket.
2. If the concert happens and the ticket price doubles to Kes 2,000, you’re lucky, you got it cheaper.
3. If the concert gets canceled or you don’t feel like going, you can refund it (but maybe you lose a small processing fee).

That’s the same idea as options: a small upfront cost for the possibility of a much bigger upside, with protection against the worst losses. 

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Intresting…..Keep posting admin

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