Options trading works by giving you the right, but not the obligation, to buy or sell an underlying asset (like a stock, index, etc.) at a specific price on or before a certain date.
Types of Options
- Call Option – Gives you the right to buy an asset.
- Put Option – Gives you the right to sell an asset.
Key Terms to Know
- Strike Price: The price you can buy/sell the asset.
- Premium: The price you pay to buy the option.
- Expiry: The last date the option is valid.
- Lot Size: Options in India are traded in lots (e.g., 25 shares of Nifty 50)
Option Trading Example:
Buying a Call Option (You Expect Price to Go Up)
- You buy a Nifty 50 Call Option at strike price 20,000, paying a premium of ₹100.
- If Nifty goes to 20,500 before expiry, you make a profit.
- Your profit = (Spot Price - Strike Price - Premium) × Lot Size.
Buying a Put Option (You Expect Price to Fall)
- You buy a Put Option at strike price 20,000 with a premium of ₹100.
- If Nifty falls to 19,500, you make a profit.
- Your profit = (Strike Price - Spot Price - Premium) × Lot Size.
Selling/Writing Options
- When you sell an option, you earn the premium.
- But you take on an obligation (higher risk). For example:
i. Sell Call: You must sell the asset if buyer exercises.
ii. Sell Put: You must buy the asset if the buyer exercises.
- Buy options for limited risk, unlimited reward.
- Sell options for limited reward, high risk (usually done by advanced traders).
- Combine options into strategies like straddle, strangle, spreads, iron condor, etc.
How it works in practice:
- Choose an Underlying Asset: Select the asset (stock, index, etc.) on which you want to trade options.
- Decide on Call or Put: Choose whether to trade a call option (if you believe the price will rise) or a put option (if you believe the price will fall).
- Pay the Premium: Purchase the option by paying the seller a premium.
- Monitor Market Movements: Track the underlying asset's price and market conditions.
- Exercise or Sell: You can exercise the option (if it's profitable) or sell it before expiration to realize a profit or limit losses.
Advantages of Option Trading:
- Leverage: Options allow you to control many shares with less capital.
- Risk Management: Options can be used to hedge against potential losses in an investment.
- Flexibility: Options offer a wide range of strategies and can be used to tailor your investment goals.
