What is Option Trading?
Option trading is a type of financial trading that allows traders to buy or sell the right to buy or sell underlying assets or sell shares at a set price within a specific time frame. A Call option is used when you expect the prices to increase/rise. A Put option is used when you expect the prices to decrease/fall.
In our Indian stock market Options trading is very popular and has many expiry days. There are 2 types of option trading one is Call option & second is Put option. Lets see and understand in briefly.
Call Option
Call options are a type of option that increases in value when a stock or index rises. They are the best-known option, allowing the owner to lock in a price to buy a specific stock by a particular date. Call options are appealing because they can appreciate quickly on a small move up in the stock or index price. That makes them a favorite with traders who are looking for a big gain.
A call option gives you the right, but not the requirement, to purchase a stock at a specific price (known as the strike price) by a specific date, at the option’s expiration. For this right, the call buyer will pay an amount of money called a premium, which the call seller will receive. Unlike stocks, which can live in perpetuity, an option will cease to exist after expiration, ending up either worthless or with some value.
You have to know the option component.
1. Strike price:
The price at which you can buy the underlying stock. Also known as the exercise price, this is the amount at which the buyers and sellers agree to execute the options contract on a future date. It constitutes the set price of the underlying asset and selling price if the options contract is exercised before the expiration date.
2. Spot price:
It is the current price of the underlying asset within the stock market. It is the underlying asset's current price at any given time in the stock market. This is the price that the buyers analyze to calculate their potential profit and loss amount. The spot price of the underlying asset directly affects the buyer's decision for the contract.
3. Option Premium:
The option's price, for either buyer or seller. Whenever the premium of an option on any stock or Nifty Bank or Nifty index is calculated, then the current price of that option is multiplied by its lot size, then the premium price has arrived.
4. Option Expiry:
When the option expires and is settled and in our Indian market weekly & monthly expiry for Options Trading.
5. Option Expiry:
When the option expires and is settled. The expiry of call and put is different for index options and stock options. in our Indian market weekly & monthly expiry for Options Trading.
All Stock Option expiry are monthly (Last Thursday of the Month) like Future Trading and Index Option weekly and monthly expiry, all index Option expiry mentioned below.
The last Thursday of the month will be the monthly expiry for all NSE Index option contracts and the Nifty weekly expiry is every week of the Thursday.
6. Lot size
To trade in calls and puts we cannot buy two or five quantities, we always have to buy in a lot size, in which there are different quantities within the lot size.
Lot size may be changed as per Stock and index price & price movements.
Nifty lot size 75
Bank Nifty lot size 30
Fin Nifty lot size 65
Midnifty lot size 120
Sensex lot size 20
For stocks also different lot sizes as per stock price.
How to work Call Option?
Call options are “in the money” when the stock price is above the strike price at expiration. The call owner can exercise the option, of putting up cash to buy the stock at the strike price. Or the owner can simply sell the option at its fair market value to another buyer before it expires. A call option owner profits when the premium paid is less than the difference between the stock price and the strike price at expiration. For example, imagine a trader bought a call option for ₹20 with a strike price of NIFTY23200CE, and the Nifty index is 20250 at expiration. The option is worth 50 (the 20250 Index price minus the NIFTY 20200CE strike price) and the trader has made a profit of ₹30 (₹30 minus the cost of ₹20). If the Index price is below the strike price at expiration, then the call option is “out of the money” and expires worthless. The call option seller keeps any premium received for the option.
Benefits of the Call Option Buying
The biggest advantage of buying a call option is that it magnifies the gains in an Index and stock’s price. For a relatively small upfront cost, you can enjoy a stock’s gains above the strike price until the option expires. So, if you’re buying a call option, you usually expect the Index or stock to rise before expiration. Imagine that Index NIFTY is trading at 23250 per share. You can buy a call option on the index with a 23200-strike price for ₹100 & Lot size 75 with an expiration next week. One contract costs ₹7500, If the market has moved potential upside, then the market will be high, it may be 100%, and 200% means profit is unlimited & with limited loss. The total premium paid by us is a higher loss which is already calculated above. Here’s the trader’s profit at expiration.
You can see the payoff graph for Option-buying profits
Benefits of the Call Option selling
For every call option bought, there is a call option sold. So, what are the advantages of selling a call option? In short, the payoff structure is exactly the reverse of buying a call. Call sellers expect the Index or stock to remain flat or decline, and hope to pocket the premium without any consequences. Let’s use the same example as before. Imagine that Index NIFTY is trading at 23250 per share. You can sell a call on the stock with a NIFTY 23200 strike price for ₹100 & Lot size 75 with expiration next week. One contract gives you ₹7500 (₹100 * 1 contract * 75 Lot size). If market will trade at same level like sideways then you will get option premium decay benefits. You have to remember it for Option Selling Exposure and span margin required which is much higher than options buying, the amount required is equal to the Future contract.
Here’s the trader’s profit at expiration.
You can see the payoff graph for Option-buying profits.
Put Option
Put options are a type of option that decreases in value when a stock or index falls. They are the best-known option, allowing the owner to lock in a price to buy a specific Index or stock by a particular date. Put Options are appealing because they can appreciate quickly on a small move down in the stock or index price. So that makes them a favorite with traders who are looking for a big fall.
A Put option gives you the right, but not the requirement, to sell a stock at a specific price (known as the strike price) by a specific date, at the option’s expiration. For this right, the put buyer will pay an amount of money called a premium, which the put seller will receive. Unlike stocks, which can live in perpetuity, an option will cease to exist after expiration, ending down either worthless or with some value.
You have to know the option component
1 . Strike price:
The price at which you can buy the underlying stock. The price at which you can buy the underlying stock. Also known as the exercise price, this is the amount at which the buyers and sellers agree to execute the options contract on a future date. It constitutes the set price of the underlying asset and selling price if the options contract is exercised before the expiration date.
2 . Spot price:
t is the current price of the underlying asset within the stock market.
It is the current price of the underlying asset at any given time in the stock market. This is the price that the buyers analyze to calculate their potential profit and loss amount. The spot price of the underlying asset directly affects the buyer's decision for the contract.
4 . Option Premium:
The price of the option, for either buyer or seller. Whenever the premium of an option on any stock or Nifty Bank or Nifty index is calculated, then the current price of that option is multiplied by its lot size, then the premium price is arrived
5 . Option Expiry:
When the option expires and is settled. The expiry of call and put is different for index options and stock options. in our Indian market weekly & monthly expiry for Options Trading.
All Stock Option expiry are monthly (last Thursday of the month) like Future Trading and Index Option weekly and monthly expiry, all index Option expiry mentioned below. Only nifty and sensex expiry have weekly expiry nifty thursday and sensex friday weekly expiry.
6. Lot size
To trade in calls and puts we cannot buy two or five quantities, we always have to buy in a lot size, in which there are different quantities within the lot size.
Lot size may be changed as per Stock and index price & price movements
Nifty lot size 75
Bank Nifty lot size 30
Fin Nifty lot size 65
Midnifty lot size 120
Sensex lot size 20
For stocks also different lot sizes as per stock price.
How to work Put Option?
Put options offer a selling position to the investors in the stock when it’s exercised. Thus, a put option is often used to protect from the downward moves within a long stock position. While put options can be used for speculation or hedging, they work a little differently when it comes to the basics. In a nutshell, the value of a put deliberately increases while the underlying stock value decreases and vice versa.
When you buy a put option, you bet that the value of the underlying stock will decrease. And when you sell a put option, you place a bet that the value of the underlying stock will increase.
A Put option owner profits when the premium paid is less than the difference between the stock price and the strike price at expiration. For example, imagine a trader bought a put option for ₹20 with a strike price of NIFTY23100PE, and the Nifty index is 23050 at expiration. The option is worth ₹50 (the 23050 Index price minus the NIFTY 23100PE strike price) and the trader has made a profit of ₹30 (₹30 minus the cost of ₹20). If the stock price is below the strike price at expiration, then the Put option is “out of the money” and expires worthless. The put option seller keeps any premium received for the option.
Benefits of the Put Option Buying:
The biggest advantage of buying a put option is that it magnifies the downfall in an Index and stock’s price. For a relatively small upfront cost, you can enjoy a stock’s downfall below the strike price until the option expires. So, if you’re buying a put option, you usually expect the Index or stock to rise before expiration. Imagine that Index NIFTY is trading at 23050 per share. You can buy a put option on the index with a 23100-strike price for ₹100 and lot size 75 with expiration next week. One contract costs ₹7500, If the market moves the potential downside, then the market will be low & daily new low, it may be 100%, 200% means profit is unlimited & with limited loss. The total premium paid by us is a higher loss which is already calculated above. Here’s the trader’s profit at expiration.
Benefits of the Put Option selling:
For every Put option bought, there is a Put option sold. So, what are the advantages of selling a put option? In short, the payoff structure is exactly the reverse of buying a Put Option. Put sellers expect the Index or stock to remain flat or decline, and hope to pocket the premium without any consequences. Let’s use the same example as before. Imagine that Index NIFTY is trading at 23050 per share. You can sell a Put option on the Index with a NIFTY 23100 strike price for ₹100 and lot size 75 with expiration next week. One contract gives you ₹7500 (₹100 * 1 contract * 75 Lot size). If market will trade at same level like sideways then you will get option premium decay benefits. You have to remember it for Option Selling exposure and span margin required which is much higher than options buying, the amount required is equal to the Future contract.
