Basics of Option Trading.
Firstly we need to know about where this option trading come from.
It is part of the derivative family.
A derivative is a contract between two or more parties whose value is based on underlying financial asset or set of the asset.
There are many derivatives:-
- Option.
- Future contracts.
- Forward contracts.
- Swaps.
- Warrants.
But today we are talking about the Basics of Option Trading.
Options are trading instrument in which a contract is made between two parties.
Stock option buyer purchases the right to sell or buy shares of an underlying stock at a predetermined price from or to the option seller within a fixed period of time.
Option Trading in India
Options can be traded on several kinds of underlying securities.
The most common one is:-
- Stocks.
- Indexes.
- Exchange traded funds.
So feel to substitute your preferred style of trading.
If you want to have quick results with limited investments and higher returns, you must go for option trading.
Shares are not of your interest, as it requires patience to get a good amount of return.
Then you must invest in option instrument.
The buyer of the option gives the premium to a seller in the hope or speculation, that the price will go high before the expiration of the agreement.
Option involve certain risks because of reason, it is able to high return.
That is why a disclaimer is always made before the investor before investing in the option instrument.
“Option involves risk and is not suitable for everyone. Options trading is speculative in nature and carries a sustainable risk of loss. Only invest with risk capital.”
Thus every single word is to be read necessarily, as, in case of loss or profit, you are already known about the facts and figures.
Stock as an investment product is to invest in the shares of the company.
And thus it represents part ownership in the company and entitles to its corporation earnings and asset.
Options Trading for Beginners
Basically, stocks are two types:-
- Equity shares.
- Preference shares.
Whereas option is typical of two types:-
- Put option.
- Call option.
There are many reasons which are mentioned below:-
- Stocks are defined in number while options are not.
- The option has fixed expiration period where else stocks have no such expiration dates.
- Expiration dates vary from weeks, months to years depending upon the regulation and the type of option you are practicing.
- Option derive their value from something else and belong to derivatives wherein stock their is no such roles.
- In option, an investor can make a profit even when the price goes down and in case of stock, an investor cannot make a profit if prices go down.
- Stock owners have voting rights in the company, where there is no such benefit to the option holder.
- The stock price is mainly primarily on market forces, whereas option prices are based to a large degree on the price of the underlying asset.
Option Trading Strategies
Option are bought and sold on the strike price.
The strike price is the price at the underlying stock are bought and sold as per the contract.
Since the option premium does not have its underlying value, so the option premium is the price that the buyer has to pay for purchasing the option.
Various factors determining premium:-
- Underlying stock price.
- Volatility in the market.
- And the days until the option expires.
Through underlying asset, the price of the option is determined.
So the underlying asset can be –
- Stocks.
- Futures.
- Index.
- Commodity.
- Currency.
How To Make Money In Call Put Option
The two types of stock options are puts and calls.
Call options confer the buyer the right to buy the underlying stock while put options give him the rights to sell them.
Participants in the options market buy and sell call and put options.
Holders are those who buy option.
Writers are the seller of the option.
Option holders are said to have long positions, and writers are said to have short positions.
Types of option –
The option can be of two types:-
- Call option.
- Put option.
The call option is an option to buy an underlying stock on or before the expiration date.
At the time of buying the call option, the buyer has to give a certain amount to the seller.
So that the seller can grant the right to buy the underlying asset at the strike price.
A put option is an option to sell an underlying stock on or before the expiration date.
The investor is bearish about the market and hoping that the price may go down of the underlying stock that is when the put option is purchased.
In this case, you want to make investment in the put option than the price of the underlying stock should go down from the strike price.
How To Trade Derivatives
Moneyness is one of the important terms, you must know about.
It is basically the relationship between the strike price of the option and the current price of the underlying asset.
Below are some of the option strategy:-
- Covered call.
- Married put.
- Bull call spread.
- Bear put spread.
- Protective collar.
- Long Straddle.
- Long strangle.
- Iron Butterfly.
- Iron Condor.
- Long call butterfly spread.
Examples Of Call Put Options
You must know about when is the option:
- In the money.
- Out the money.
- At the money.
- When is an option in the money?
Call option – When the underlying stock price is higher than the strike price.
Put option – when the underlying stock price is lower than the strike price.
- When is an option out of the money?
Call option – When the underlying stock price is lower than the strike price.
Put option – When the underlying stock price is higher than the strike price.
- What is at the money?
When the underlying stock price is equal to strike price.
These are the Basics of Option Trading, now you can implement it to Basics of Option Trading strategy.
Dispersion trading strategy is one of strategy, you can start to implement.
As it is very easy to start for the option trading lovers.
So if you want to invest in options trading, you should know every determinant of it.
As it contains unlimited loss and has a certain amount of loss.
But once you understand, how options trading works, one can leverage unlimited profit.
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