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Options Explained-Intro, Types and How to trade

Published on Monday, April 2, 2018 by Team | Modified on Monday, February 12, 2024

Options have emerged as a popular investment avenue. In the last few years, we have seen a growing participation from retail investors in the options market. Though options trading is an old phenomenon in the world markets, options trading in India started with the launch of index options on June 4th, 2001. On July 2nd, 2001, stock options were launched. And from there, index and stock options have risen to over Rs 4,45,561 crores in value in 2017-18.

Retail participation in option market

Year Index Options Stock Options
No. of contracts Premium Turnover (Rs cr.) No. of contracts Premium Turnover (Rs cr.)
2017-18 115,94,95,408 3,27,703.55 10,02,31,648 1,17,858.86
2016-17 106,72,44,916 3,50,021.53 9,21,06,012 95,570.09
2015-16 162,35,28,486 3,51,221.01 10,02,99,174 61,118.39
2014-15 137,86,42,863 2,65,315.63 9,14,79,209 61,732.59
2013-14 92,85,65,175 2,44,090.71 8,01,74,431 46,428.41

Source: NSE

What is an option?

Options are a form of 'derivative'. Derivatives are financial instruments that derive their value from an 'underlying asset", e.g. shares in a company, a currency, gold, etc.

Curd is a derivative of milk, i.e. derived from milk. Similarly, options are derived from an underlying financial instrument, e.g. a share of a company, a currency, or gold.

As we all know, the price of curd moves up and down according to the rise and fall of the price of milk. Similarly, the price of options moves up and down with the price of the underlying asset.

Options definition

An option is a derivative, a contract that gives the buyer the right, but not the obligation, to buy or sell the underlying asset by a certain date (expiration date) at a certain price (strike price).

Options trading meaning

Options trading involves the purchase or sale of options contracts. These contracts are agreements that allow the holder to buy or sell several underlying assets at a fixed price up to a certain date. Investors do not necessarily have to own the underlying asset to buy or sell an option.

How options are traded?

In the normal stock market, investors buy and sell shares. The prices of shares often move up or down on the market. If you think a particular share will go up in the next few days/weeks/months, you buy a certain number of shares by paying the market value at that time. The transaction value (share price + brokerage fee) is deducted from your trading account and the shares are delivered to your account within a few days.

If the share price reaches your expectation, you sell the share and make a profit. However, if the share price falls below your purchase price, you make a loss on the sale. In both cases, the shares are deducted from your trading account and the transaction value is credited to your account.

Options trading differs slightly from share trading. In options trading, you do not buy shares and have them delivered to your account, but you buy the opportunity to perform an action at a predetermined price and within a predetermined time. The action is to buy/sell or get out. The second difference is that there is no delivery with options. All transactions are settled in cash.

An option contract gives you the opportunity or choice to enter into a transaction to buy a fixed number of shares at today's price at a future date. To purchase this option, you must pay an amount (which is significantly less than the value of the underlying shares). The amount you pay is called the premium. If the transaction does not seem advantageous to you at that time, you have the option to get out of the transaction. In this case, you lose the premium you paid when you bought the option.

Options trading key terms

Every option contract mentions its strike price, premium, lot size and expiry date.

  • Strike price: The price on which the buyer and seller of an option have agreed to conclude the option contract is the strike price. Each option on an underlying security has several strike prices.
  • Premium: The payment that the buyer makes to the seller to acquire his right to an option contract.
  • Expiration day: The last day on which the option holder can exercise the option.
  • Lot Size: The specified number of units of the underlying asset that are part of a single option contract. The lot size is different for each share and is determined by the exchange.

Options trading example

Suppose there is an option available on Infosys for August at a strike price of Rs 2000 and a premium of Rs 200 for a lot size of 100 Infosys shares. This option gives you the right to buy 100 shares of Infosys at Rs 2000 anytime from now till the end of August. To buy this right, you pay a premium of Rs 200 x 100 shares = Rs 20000. Now, if the market price of Infosys is above Rs 2200 at any time in August, you can exercise the right and make profits. However, if you find that the price is below Rs 2200 and exercising the right would lead to losses, you can choose to exit. You will then lose the premium paid when you buy the option. So with an option, you can buy shares if it is profitable for you and exit the trade if you see that it is a losing trade for you.

So an option allows you to buy shares when it is profitable to you and opt out of the deal when you see there's a loss for you.

Types of Options

Options are of two types - Calls and Puts

Calls give you the right, but not the obligation, to buy a certain amount of the underlying asset at a certain price on or before a predetermined date.

Puts give you the right, but not the obligation, to sell a specified amount of the underlying asset at a specified price on or before a predetermined date in the future.

Depending on how they are exercised, options can be classified as European or American options.

American options are contracts that can be exercised at any time up to the option's expiration date. In India, American options can be exercised on individual securities such as Reliance, SBI, etc.

European options can be exercised only on the expiry date. Options on indices like Nifty 50, Nifty Bank, etc. are European options.

In India, all exchange-traded options are European options, regardless of whether they are index options or equity options. 1. Call contracts are represented as CE, i.e. Call European 2. Put contracts are represented as PE, i.e. Put European

Option order types

There are 4 types of orders for options:

  1. Buy to open: the most common of all order types is used to open a position and buy a specific option contract.
  2. Buy to close: The buy to close order is also used to buy an options contract, not to open a new position, but to close an already opened position.
  3. Sell to open: It is used to open a position in an options contract by selling it short. If you think that the value of a particular option contract is likely to fall and you want to take advantage of this, sell that option contract short with a "sell to open" order.
  4. Sell to close: This option is used to close a position that you have opened with a "buy to open" order. So if you have bought a particular contract and want to sell that contract - perhaps after it has risen by a certain amount - then you would use a "sell to close" order to sell your contract and realize the profit.

Options example

An option name is made up of these components:

  • Underlying name
  • Expiration date
  • Strike price
  • Type of option

For example Bank Nifty is trading at Rs. 43700 and a trader wants to buy a call option with a strike price of Rs. 43600. Since the index options have both weekly and monthly expiry, it looks like this:

A weekly contract: BankNifty 6thDEC 43600 CE


  • The underlying name is BankNifty
  • The expiration date is 6thDEC
  • The strike price is 43600
  • The type of option is CE, i.e. Call European

A monthly contract looks like this: BankNifty DEC 43600 CE


  • The name of the underlying is BankNifty
  • The expiration date is DEC
  • The strike price is 43600
  • The type of option is CE, i.e. Call European

A put option looks like this:

  • Weekly contract: BankNifty 6th DEC 43600 PE
  • Monthly contract: BankNifty DEC 43600 PE

Example of a Call Option

You buy a call option on SBI for August at a strike price of Rs 1000 and a premium of Rs 100 for a lot size of 100 shares. This gives you the right to buy 100 shares of SBI at Rs 1000 anytime from now till the end of August. To acquire this right, you pay a premium of Rs 100 x 100 shares = Rs 10000. Now, if the market price of SBI is above Rs 1100 at any time in August, you can exercise the right and earn profits. Suppose the option price at expiry is Rs 1150. Since all financial derivatives are cash-settled and there is no delivery of the underlying, the contract is settled by paying an amount of Rs 150 (strike price - market price) x 100 shares Rs 15000.

Your profit is Rs 15000 - Rs 10000 = Rs 5000.

Now if the share price falls below Rs 1000 on the expiry date, you have the right not to exercise this option. You would only lose the premium amount of Rs 10,000 that you paid at the time of cancelling the option.

Put option example

You buy a put option on SBI at a strike price of Rs 1200 with a premium of Rs 50 for a lot size of 100 shares. You pay a premium of Rs 50 x 100 = Rs 5000 while buying the option. If the share price of SBI is below Rs 1250 on the expiry date, you make a profit by exercising your right to sell the option. However, if the share price has risen above Rs 1250, you cannot exercise the option and lose the premium.

Some options jargon you need to know:

  • In the money:For a call option, 'in the money' means that the price of the underlying asset is above the strike price. For a put option, 'in the money' means that the price of the underlying asset is below the strike price.
  • Out of the money:In the case of a call option, 'out of the money' means that the price of the underlying is below the strike price. In the case of a put option, 'in the money' means that the price of the underlying is above the strike price.
  • At the money:when the price of the underlying is equal to the strike price.

Options Pricing

The price of an option is made up of two different parts: the intrinsic value and the time value. The intrinsic value is a measure of the profitability of an option based on the strike price compared to the share price of the share. The time value is based on the expected volatility of the underlying and the time until the option expires.

Factors that drive the price of an option are:

  • Current stock price: The upward or downward trend in the share price has a direct effect on the price of the option, albeit not to the same extent.
  • Intrinsic value: The intrinsic value is the amount by which the strike price of an option is profitable or in the money compared to the share price of the share. If the strike price of the option is not profitable compared to the share price, the option is said to be "out of the money". If the strike price is equal to the share price, the option is considered "at the money".
  • Time to expiration or time value: The time value is directly related to the time an option has until it expires and to the volatility or fluctuations in the share price. The more time an option has until expiry, the greater the chance that it will end up in the money. As a general rule, an option loses one-third of its value in the first half of its term and two-thirds in the second half.
  • Volatility: Generally, shares with high volatility have a higher probability that the option will be profitable or in the money at expiry.

Read more on options pricing here.

Options expiry day

The option expiration date is the specific date and time at which the option contract becomes invalid. In the case of American options, the buyer can exercise the option at any time up to and including the expiry date. In the case of European options, the holder can only exercise the option on the expiry date itself.

Options that are well before the expiry date are more expensive than options that are closer to the expiry date. This is because they lose value due to time decay. Options have different expiration dates: daily, weekly, monthly as well as 1 year or longer than 1 year, which is called LEAPS (Long-Term Equity Anticipation Securities).

  • Options expiry for stock options: All stock options expire on the last Thursday of each month.
  • Options expiry for index options: Index options with weekly expiry expire every Thursday for Nifty and Bank Nifty contracts. The weekly FINNIFTY contracts expire every Tuesday. These contracts are called Near-Week contracts, Next-Week contracts, and Far-Week contracts.

Index options with a monthly expiration date expire on the last Thursday of each month.

Options leverage

When trading options, you can increase your buying power by using leverage. This means you can buy more with less capital.

This is the great advantage that options offer over other financial instruments, which is why they're often used by investors who don't have large amounts of capital.

Investors trading shares, for example, must have enough money in their accounts to cover the total cost of buying shares before they can take a position. With options, on the other hand, you can pay a relatively small amount for an option contract.

Leverage effects also harbor downside risks. If the price of the underlying asset moves in an unfavorable direction, the leverage effect can increase the percentage loss of the investment. Options offer their holders a predetermined level of risk. However, if the holder's options expire worthless, this loss can equal the entire amount of the premium paid for the option.

Options margin

Margin is the amount required to execute a transaction. The margin required for intraday trading is much lower than that required for delivery trading. For example, if ABS is traded at a price of Rs. 2000 and you buy 10 shares for delivery, the margin required for this trade is Rs. 20,000 i.e. a full margin. However, for intraday trading, the margin required may be less than this amount.

Options trading opening time in India

Pre-market session: The 15-minute pre-market session for stock options begins at 9:00 am. During this period, investors can place orders, modify existing orders, or withdraw orders for the following trading session.

Regular session: It starts at 9:15 a.m. and ends at 3:30 p.m.

Options trading charges in India

Here are the various charges associated with options trading:

  1. Brokerage fees: In options trading, brokerage fees are usually charged per lot at a fixed rate of Rs. 10 and Rs. 20 per lot.
  2. Securities Transaction Tax or STT: Securities Transaction Tax is levied at the rate of 0.05% of the premium value (not the notional value) and is applicable only on the sell side of the option, not on the buy side.
  3. Exchange transaction fee: The exchange transaction fee is levied by the stock exchanges. Brokers only collect it on behalf of the trading platform. A maximum of 0.05% of the premium value of the transaction is charged.
  4. Goods and Services Tax (GST): GST is an 18% levy that includes both the brokerage and transaction fees and the brokerage amount.
  5. SEBI charges: SEBI charges are levied at a fixed rate of Rs. 5 per Rs. 1 crore in transaction value. The broker collects these charges and remits them to SEBI.
  6. Stamp duty: Stamp duty is still a tax at the state level. In the past, stamp duty was levied at different rates in different states of India, but it has now been standardized across the country. Normally the rates are between 0.002% and 0.015%.

Option chain

An option chain is a list of all option contracts. The option chain has two sections: call and put. The list contains information about premium, volume, open interest, etc. for different strike prices.

Components of an option chain

  • An option chain consists of the following components:
  • OI: OI is an abbreviation for Open Interest
  • Chng in OI
  • Volume
  • IV: IV is an abbreviation for Implied Volatility
  • LTP: is an abbreviation for the Last Traded Price of an option
  • Net Chng: This is the net change in the LTP
  • Bid Qty: The number of buy orders for a specific strike price
  • Bid price: This is the price specified in the last buy order
  • Ask Qty: The price specified in the last sell order
  • Ask Qty: The number of open sell orders for a given strike price

Read more.

Underlying asset meaning

Underlying assets are the real financial assets on which the price of a derivative is based. The price of the derivative is therefore dependent on the price of the underlying asset. Any change in the price of the underlying is reflected in the price of the corresponding derivative.

The price of an underlying is often referred to as the current market price or CMP. Market participants also refer to the CMP as the spot price. Both terms essentially mean the same thing.

The underlying price or current market price or spot price is a fundamental component for calculating the price of a derivative. The strike price or CMP is the last traded price of the underlying and often reflects the true value or market price of the underlying.

Underlying asset types

There are different types or classes of underlying assets which have unique characteristics, which in turn affect the nature and structure of the derivatives associated with each type of underlying asset. All the underlying assets are subject to market risk, balance sheet risk, and general economic risk factors, as their price depends on both fundamentals and market forces of supply and demand.

  • Stocks: Stocks are individual securities such as Reliance, Airtel, and Tata Steel.
  • Indices: Indices are a group of securities. They refer to indexes like Nifty50, Bank Nifty, Nifty Midcap50, India VIX, etc.
  • Commodities: Commodities include perishables like fresh fruit, non-perishables like nuts and seeds, and (bars of) precious metals like gold, silver, etc.
  • Currency: Currencies refer to the legal tender used in various countries around the world such as Rupee (₹), Euro (€), etc. These are subject to interest rate risk, geopolitical risk, and sovereign debt risk. E.g. USD/INR, GBP/INR, EUR/USD, etc.
  • Bonds: Bonds are a type of debt instrument, a financial instrument used to borrow money. They are subject to default risk, interest rate risk, and counterparty risk. For example: T-Bills, G-Sec (Indian government securities), LIBOR, etc.

Frequently Asked Questions

  1. 1. Are options trading worth it?

    Buying options offer upside potential, with losses limited only to the option premium. However, this can also be a disadvantage as the options expire worthless if the stock does not move enough to be in the money.


  2. 2. Are options trading losses tax deductible?

    If you declare your option loss on your income tax return, you can benefit from several advantages, such as the Tax deduction: One of the main advantages of the loss is that you can offset it against other income you have earned. A loss from an F&O trade can be offset against all income except your salary.


  3. 3. Is options trading gambling?

    Although options trading is generally not considered gambling per se, options trading, just like gambling, involves some risks.


  4. 4. Is options trading better than stocks?

    Options trading has several benefits over stock trading:

    • Options allow you to achieve a similar return to shares with less money, so they are a way of limiting your risk within certain limits.
    • Options can be a useful strategy if you are an experienced investor. Experienced investors know how to limit their risk, and they understand the risks they are taking when they use a particular options strategy.
    • Generate income. Some shareholders sell call options against their stock positions or write put options to generate income. Such strategies can be attractive and relatively low-risk ways to use options.


  5. 5. Is option trading good for beginners?

    Options trading can be risky and difficult for new traders, so do not enter this field without proper research and knowledge.

    Beginners can start with some basic strategies such as buying calls, buying puts, selling covered calls, buying protected puts, etc.


  6. 6. Can options trading be profitable?

    Options traders can profit as option buyers or option writers. Options offer profit opportunities in both volatile phases, regardless of the direction in which the market moves. This is possible because options can be traded in anticipation of a market rise or fall.


  7. 7. Does options trading requires margin?

    Buying options is usually a Level I trade because it doesn't require margin, but selling naked puts may require a Level II trade and a margin account. Level III and IV accounts often have lower margin requirements.


  8. 8. Does options trading use leverage?

    Options can have a leverage effect. This means that an option buyer can pay a relatively small premium for market exposure in relation to the contract value (usually 100 shares of the underlying stock). An investor can make large percentage gains from comparatively small, favorable percentage movements in the underlying product.


  9. 9. What is the purpose of options trading?

    People trade options for three reasons:

    1. Hedging: options can serve as a "hedge" or a form of insurance to minimize the risk of sudden market changes.

    2. Speculation: Similar to stocks, options can also be used for speculative purposes. You can make a bet on how a stock will perform over time and then buy an options contract that reflects that assessment.

    3. Profit: Some traders also use options for general profit-making. That is, options can play a role in their larger investment strategies. Sellers can make a profit on the premiums they charge buyers.


  10. 10. Options trading is it worth it?

    Options trading is a great investment opportunity. A trader may choose to trade options if they are confident in the performance of a particular asset but find it too expensive. An options contract can be much cheaper than the original asset. A trader may also choose to trade options if they are long on an underlying asset but are concerned that the price may move in a different direction and want to hedge against a potential loss.


  11. 11. How to do option trading India?

    A trader can do options trading in the following steps:

    • Open an options trading account
    • Pick which options to buy or sell
    • Predict the option strike price
    • Determine the option time frame

    Learn more on how to do options trading for beginners here.


  12. 12. How to start option trading in India?

    Most online brokers today offer options trading. As a rule, you must submit an application and be approved for options trading. You also need a margin account. Once you are approved, you can place orders to trade options, similar to stock trading, using an options chain to determine the underlying asset, expiration date, strike price and whether it is a call or put option. You can then place limit or market orders for that option.


  13. 13. What are the different types of underlying assets?

    In the Indian market, various types of underlying assets can be traded as derivatives. These include stocks, bonds, commodities, interest rates, market indexes, and currencies.


  14. 14. What is underlying asset?

    Underlying is an investment term that refers to the real financial asset or security on which a financial derivative is based. Underlying assets include shares, bonds, commodities, interest rates, market indexes, and currencies. An underlying asset of the derivative contract is that which is to be bought or sold at a future date.


  15. 15. What is option expiry?

    The expiration of an option is the specific date and time at which the option contract becomes invalid and ceases to exist.


  16. 16. What happens on option expiry day?

    On the expiration date of the options, no more options contracts can be traded and all remaining positions become worthless - they simply disappear from your account.


  17. 17. What time is option expiry?

    All monthly options expire on the last Thursday of each month, except for FinNifty contracts, which expire on Tuesday of each month. Weekly contracts, on the other hand, expire every Thursday. On expiry days, options contracts expire at the end of trading hours.


  18. 18. How to check option expiry date?

    Checking the expiry date of options contracts is simple. A trader must remember that all monthly options contracts expire on the last Thursday of the month after the market closes. Weekly options expire every Thursday. However, derivatives on the Fin Nifty index expire on Tuesdays.


  19. 19. Why options expire on Thursday?

    Due to the T+1 settlement cycle for F&O contracts, options expire on Thursdays. On the last Thursday of the month, all index and stock contracts are closed and cash settlement takes place on Friday evening (deposit and withdrawal of funds), unless Friday is a trading holiday.


  20. 20. When options expires in India?

    In India, stock options expire on the last Thursday of every month. On the other hand, index options with weekly expiry expire every Thursday for Nifty and Bank Nifty contracts, and FINNIFTY weekly contracts expire every Tuesday. The index options with monthly expiry expire on the last Thursday of every month.


  21. 21. What happens if you don't sell options on expiry?

    If the options are not exercised at the end of the term, the system will automatically square off the position, unless you have opted for physical settlement. Physical settlement is only possible for stock options.


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2. GRAv   I Like It. |Report Abuse|  Link|June 28, 2021 9:02:45 AMReply
If option rate is more than strike price on the day of expiry for call buy option (Out of the money), & I dont settle the poisition , will i get the benefits
1. Nikhilesh Kumar Jha   I Like It. |Report Abuse|  Link|November 11, 2018 2:13:34 PMReply
Concept of options has been made clear by example and explanation.