Options trading involves the buying and selling of contracts that grant the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified timeframe. Unlike traditional stock trading, options trading offers traders the opportunity to profit from price movements in various assets without needing to own the assets outright.
Options trading can be a lucrative endeavor for those who understand its intricacies, but it can also be a minefield for beginners. If you’re new to the world of trading, especially options, it’s crucial to equip yourself with the knowledge and strategies necessary to navigate this complex market successfully. In this comprehensive guide, we’ll delve into the fundamentals of options trading and provide you with actionable tips to kickstart your journey towards profitability.
Options Trading, How to do Options Trading?
What is Options Trading?
Options are financial tools that provide the holder with the right, though not the obligation, to purchase or sell an underlying asset at a predetermined price within a specified timeframe. They are versatile instruments employed in a variety of investment strategies. There are two main categories of options:
Call Options :A call option grants the holder the right to purchase the underlying asset at the strike price before the expiration date. Investors commonly utilize call options when they expect the price of the underlying asset to increase.
Put Options: Conversely, a put option gives the holder the right to sell the underlying asset at the strike price before the expiration date. Investors often use put options when they anticipate a decline in the price of the underlying asset.
Terminologies in Options Trading
Before going any further, it’s essential to understand some key terms relating to options trading:
Strike Price: The specified cost at which the underlying asset can be purchased (for a call option) or sold (for a put option).
Premium: The price that the option buyer pays to the option seller is referred to as the option premium.
Expiration Date: The date specified in an option contract is known as the expiry date or the exercise date.
Extrinsic Value (Time Value): The remaining part of the option’s premium, beyond its intrinsic value, that considers elements such as time remaining until expiration and implied volatility.
Intrinsic Value: The variance between the strike price of an option and the present market value of the underlying asset.
Index Options: These are the options that have an index as the underlying. In India, the regulators authorized the European style of settlement. Examples of such options include Nifty options, Bank Nifty options, etc.
Stock Options: These options are linked to individual stocks, where the stock itself is the underlying asset. The contract provides the holder with the privilege to purchase or sell the underlying shares at the designated price. Additionally, the regulatory body has approved the American style of settlement for these options.
Lot size: Lot size indicates a specific quantity of shares, constituting a unit in options trading. The lot size varies for each security or share and is determined by the exchange. For example, in the case of Tata Motors, one unit consists of 1425 shares.
American Option: This type of option allows exercise at any time until its expiration
European Option: These options can only be exercised on the expiration date.
How Does Options Trading Work?
Options trading involves the buying and selling of contracts that grant individuals the right to buy or sell a specific quantity of an underlying asset at a predetermined price by a set date.
It’s crucial to grasp that purchasing or selling an option doesn’t mandate exercising it upon contract expiration. Options are termed “derivative securities” because their worth is derived from underlying assets, securities, or other financial instruments.
This implies that changes in the value of underlying assets, market conditions, and implied volatility directly impact options prices. Options traders speculate on future price movements of these underlying assets, seeking to profit from such changes. In essence, options serve as financial instruments where investors can capitalize on anticipated movements in the values of related assets.
How to trade call options?
Buying a Call Option in the stock market means that you are purchasing a contract to buy a specific stock or asset at a predetermined price for a specified period. When buying a Call Option, consider the following:
- The number of lots you want to trade.
- The expiration date you prefer for the trade.
- Your risk tolerance.
- The market’s volatility.
A Call Option is more profitable when you anticipate that the stock or asset’s price will increase before the expiration date.
How to trade put options?
When you buy a Put Option, you are acquiring a contract that gives you the option to sell a specific stock or security at a predetermined price until a specified expiration date. For Put Options, you need to consider the same factors as with Call Options. Buying a Put Option is advantageous when you believe that the price of a particular stock or security may fall before the expiration date. If you purchase a Put Option at a specific strike price, as the price of that stock or asset decreases, you stand to benefit.
How to trade options?
Consider the following steps to trade options:
Open the Trading Account: The process of opening a brokerage account varies from a regular one, particularly if you intend to engage in margin trading (utilizing borrowed funds). Options trading platforms might necessitate details about your investment goals, trading history, personal financial status, and the specific types of options you plan to trade.
Open Trading account Best discount broker in India Zerodha, Upstock, Angle one.
Select Your Preferred Options Contract: With a multitude of options available, it’s crucial to conduct thorough research on diverse strategies and stocks. Ensure you’re well-informed about the associated disclosures and assess the risks you’re comfortable taking before committing to a particular direction.
Determine the Strike Price: The effectiveness of purchasing an option depends on the stock price closing favorably “in the money.” The strike price denotes the price at which the underlying security can be bought or sold (exercised) within your options contract.
Execute Your Trade: Ultimately, pay the premium and broker commission to secure ownership of the contract.
Options trading can be done in two ways –
Buying options, selling options
As I told above most people do option buying because it requires less capital but it is also true that people earn big money only by selling options.
But this does not mean at all that you cannot earn money from option buying, rather many option buyers are earning lakhs and crores of rupees a day, all they need is the right knowledge and experience.
Profitability Scenarios in Options Trading
In-the-money Options: An option is deemed “in-the-money” when it possesses intrinsic value, indicating that it would be advantageous if chosen to be executed.
For example, in a call option on the index, if the current index value is higher than the strike price (spot price > strike price), the option is said to be in-the-money.
Out-of-the-Money (OTM): An option is considered out-of-the-money when it has no intrinsic value and would not be profitable if exercised.
For example, in the previous case, if the index value is lower than the strike price (spot price < strike price), the option is said to be OTM.
At-the-Money (ATM): An option is considered at-the-money when the option’s strike price is equal to the current market price of the underlying asset.
For example, in the previous case, if the current index value is equal to the strike price (spot price = strike price), the option is ATM.
Learn More : What Are ITM, ATM, OTM and Which Is Better?
How to learn option trading?
To learn options trading, you need to understand things like option chain data, market research, strike prices, put-call ratios, trend analysis, and various strategies. By mastering different strategies, you can potentially turn losses into profits.
If you’re interested in learning options trading, the first step is to decide which instrument you want to trade—whether it’s Nifty, Banknifty, or stock options.
let’s explore the essential steps to kickstart your options trading journey.
Educate Yourself :Before delving into options trading, equip yourself with a solid understanding of the market, underlying assets, and the factors influencing option prices. Resources like online courses, and Books reputable financial websites, and literature from reliable sources can be invaluable. Â You can also read my book Price Action Trading Beginner to Advanced, Can buy my book from Flipkart or Amazon.
Choose the right Broker : Selecting the right broker is pivotal. Look for a platform that offers a user-friendly interface, educational resources, and a seamless trading experience. Brokerage fees and the range of available options should also factor into your decision-making process.
Analysis : Technical and fundamental analyses are indispensable tools for option traders. Learn to interpret market trends, analyze price charts, and assess economic indicators. This knowledge empowers you to make strategic decisions and identify lucrative opportunities.
Define Your Risk Tolerance :Establish clear goals for your option trading endeavors. Whether it’s capital growth, income generation, or hedging against market volatility, defining your objectives guides your strategy. Assess your risk tolerance to make informed decisions aligned with your financial comfort zone.
Learn more details: Top 5 Risk Management Strategies for Traders
Advantages of Option Trading
Cost-Efficiency: Opting for buying options involves a comparatively lower initial investment than outright purchasing stocks, making it a more economically viable approach for traders.
Risk Involved: The risk associated with options is relatively lower than that of futures or cash markets. Options carry a risk of loss equal to the premium paid. However, writing or selling options may carry more risk than purchasing an underlying asset.
Price Lock-in :Options empower investors to secure a predetermined price (strike price) for the underlying asset, providing a degree of price security until the option reaches its expiration date.
Portfolio Enhancement :Options can augment an investment portfolio by offering supplementary income, leverage, and protective strategies against market downturns.
Flexibility :Options trading inherently offers flexibility, allowing traders to employ various strategies before the contract expires. These strategies include adding shares to their portfolio, selling shares for profit, or selling the contract itself.
Hedging: Using options reduces the risk associated with current holdings and acts as a hedging tool. Traders can virtually eliminate any risk associated with trade by combining options.
Leveraging Capital, The Power of Options : One of the standout features of options trading is leverage. With a relatively small upfront investment, traders can control a larger position in the underlying asset. This amplification of trading power allows for substantial potential returns, but it’s crucial to note that it also comes with increased risk.
Disadvantages of Option Trading
Complexity: Options trading can be complex, especially for beginners. Understanding the intricacies of various options strategies, including factors like strike prices and expiration dates, requires a learning curve that may be challenging for some investors.
Limited Lifespan : Options contracts have a finite lifespan, and if the market doesn’t move in the expected direction within that timeframe, the option may expire worthless, resulting in a complete loss of the investment.
Market Volatility :Options prices are influenced by market volatility. Sudden and unexpected market movements can lead to increased option prices, making it harder for traders to predict and profit from price changes.
Time Sensitivity :Options are sensitive to time decay, meaning their value diminishes as time passes. This time sensitivity can put pressure on traders to make timely and accurate decisions.
Market Predictions are Challenging :Successful options trading often requires accurate predictions about the direction and timing of market movements. Predicting market conditions with consistency is challenging even for experienced traders.
Also read :
- What Is Intraday Trading And How Does It Work?
- What is Swing Trading, Strategies with Example
- Understanding Support and Resistance Trend Analysis
- 30 Candlestick Patterns and Charts Every Trader Should Know
- What is Trendline, How to draw a Trendline, How to It use?
Conclusion
Options trading is flexible and offers traders abundant opportunities in various market conditions. Despite the inherent high-risk nature of options investments, traders can choose basic strategies that come with limited risk. Even an investor who prefers lower risks can leverage options to enhance overall returns.
Nevertheless, it is crucial to grasp the associated risks and thoroughly evaluate diverse scenarios before committing to an investment. Successful returns in options trading demand both patience and a comprehensive understanding of the markets and financial instruments.
FAQs Options Trading, How to do Options Trading?
How to do option trading?
You will first have to open an options trading account, choose the option you want to buy or sell and predict the options strike price for starters.
Which options trading is safe ?
Covered calls are one of the safest options trading methods. It enables the trader to sell a call and buy the underlying stock to reduce risks. This way, one can mitigate their risk while trying to maximise the returns.
How much money do option traders make?
Option traders can earn varying amounts of money. Successful option traders can make millions of rupees in a single day, but behind their success lies years of hard work and practice.
What is Options Trading, How to do Options Trading?
Options trading involves buying or selling contracts granting the right to buy or sell assets at a predetermined price. Learn the basics, understand the risks, and choose a reliable options broker. Develop strategies, focusing on calls and puts, and practice with small positions before venturing into larger trades.
What is the trick for option trading?
The key to successful option trading lies in thorough research, strategic planning, and risk management. Understand market trends, choose options with care, and employ well-thought-out strategies. Stay disciplined, avoid emotional reactions, and continuously educate yourself. Consistent analysis and a prudent approach are essential for navigating the complexities of option trading.
