The stock market is a diversified market with lots of opportunities. Traders who are dealing with the market regularly must be acquainted with the segments of the derivative market. Literally, derivative means a value which is derived from an underlying asset. However, the particular market has different financial instruments such as future, options, swaps. Previously, we’ve covered future derivative. Today’s section is the options trading. Options are one of the riskiest as well as the high returnable instrument under the derivative market. Options itself is a vast field and can be categorized in a number of ways. Let’s start with the Basics of Options Trading.
Basics of Options Trading
In the Basics of Options Trading, let’s just check the definition of it. According to the formal definition of Options trading, it is an agreement between two parties buyers and sellers of an underlying asset at a predetermined price and within a fixed period of time. Under a particular options contract, buyers are named as holders and sellers as the writer. In order to do options trading, holders (Buyers) only have to pay a minimum premium to the writer (Sellers). So, unlike the future trading, options don’t need much capital. Therefore, Options give the right to the buyers to execute the contract while sellers have the obligations. Hence, buying options contract is riskier in comparison to selling it.
Types of Options Orders
The fundamental concept of Options order consists of different parameters. This particular segment contains four main options orders. Here, we are going to concentrate only on these four special options orders. Buy to open orders, Buy to close orders, Sell to open orders and, Sell to close orders.
Buy to Open Orders
This Buy to open orders are pretty simple and commonly placed orders in options. In order to open and carry a position, one could place this particular order to purchase the options contracts. So, if investors are sure about the rising of the price value, they can exercise the order of the specific options.
Buy to Close Orders
This order also uses to purchase options. The main difference between the previously described Buy to Open and Buy to Close orders is BTC orders are used to close a previously opened position. If traders want to close the position, they have to place a Buy to Close order on that options agreement.
Sell to Open Orders
By using the Sell to Open Orders traders can open options position by short selling it. If traders predict the falling price of a contract, they would short sell those particular options by applying this Sell to Open Orders. If traders want to take full advantage of the falling market price, they can use the order type.
Sell to Close Orders
The order type is also recognized as the second most popular orders in options trading system after the Buy to Open Orders. For closing a position (opened through a Buy to Open Order) the Sell to Close Orders is used. Suppose, traders bought a contract and after it had gone up a certain level, they want to sell it, then they could use the specific order.
Types of Options Trading
In the article “Basics of Options Trading”, here is the main segment. Options trading can be categorized in many ways. However, in order to clarify the types of options trading, we are trying to broadly classify the types.
Options Types based on the Trading Method
- Calls: Call Options offer the right to buy an underlying asset at a predetermined price. However, if traders are confident and predictable about the uplifting market price, they can book a call option. Depending on the terms of the contract, calls have the expiry date. Hence, traders can buy the underlying asset prior to or on the date of expiry.
- Put: Put options carry exactly the opposite statement of Calls. Here, Owners get the right to sell the underlying asset at a predetermined price and date. So, in case, if traders predict the falling price level, they could book the put options. There is an expiry date too.
Options Types Based on Underlying Security
- Stock Options: Here, the underlying assets are share from the publicly listed companies.
- Forex or Currency Options: This type of options deals with the specific currency at a pre-decided exchange rate.
- Index Options: Just like the Stock options, in Index Options the underlying security is index. There are many indices in the stock exchange such as S&P 500, Nifty etc. However, Options trading can also be executed through indices.
- Commodity Options: The Commodity options can be in physical commodity form or a commodity future contract form.
- Future Options: This specific future options contract offers the right to enter into a particular future contract.
- Basket Options: It is a diversified options contract, is named as basket options contract. However, the contract consists of stocks, commodities, currencies or other financial securities.
Options Types Based on Expiration
- Regular Options: Under the regular options, traders will get the choice of at least four different expiration months. Here, traders are able to choose a preferred expiration date according to their requirements.
- Weekly Options: The weekly options also known as weeklies which were introduced in 2005. These options are only available on very limited underlying securities. It is almost similar to the regular option. The only difference between the two is weekly options have a much shorter expiry period.
- Quarterly Options: The particular options are often termed as quarterlies. The options are quite different from the regular contract, it expires on the last day of the expiration month instead of the third Friday of the expiry month.
- Long-Term Expiration: The long-term expiration anticipation securities often known as LEAPS which is applicable to a wide range of underlying securities. Hence, its expiration period is always in the month of January.
Terms in Options Market
- Options Premium: In options premium, there are two components, intrinsic and time value. Premium is decided according to the Options contract amount.
- Lot Size: It defines the number of the underlying security.
- Expiry Date: The day when the contract will expire.
- Spot Price: Spot market trading price is referred to as the spot price.
- Strike Price: This is the price at which an asset is sold or purchased.
Options Trading FAQ
If you buy call options you get the right but not the obligation to buy the underlying asset. Similarly, if you buy put options you get the right but not the obligation to sell the underlying asset. On the other hand, if you sell call or put options you will have obligation to sell or buy the underlying asset.
If you buy options, you only need the total premium paid multiplied by the lot size. Suppose you buy Nifty’s Aug 11000 call option at 20, you only need 20 x Nifty’s lot size 75 = 1500 rupees. But options selling can ask for a hefty margin to be paid, which will depend on the broker to broker.
First, you need to open a Trading and Demat account with any stockbroker in India. Next, you must have futures and options (FNO) enabled in your account. To enable FNO you need to submit your 6-month bank statement or any other income proof to the broker. Once FNO is enabled in your account you can transfer funds and start trading in options.
Yes, we can make money trading options if we have proper knowledge of the market direction. Apart from simple market direction options also have a time component. So options buyers need to have an eye on the time left till expiry for making money.
To make money in trading options we need to buy the option at a low price and sell it at a high price. Similarly, you can make money by short-selling options, but that requires a much higher margin and is executed by experienced traders.
Yes, options can be day traded like any other stocks. The brokers offer some margin too on the day trading of calls and puts. As an example, Zerodha offers 1.4 times margin in intraday trading of options on the buy-side. Short selling options, on the other hand, require an enhanced margin.
Options Trading Strategies
- Leverage: Benefits of leverage is one of the main advantages of the options trading. Lumsum profit can be made by investing a few amounts of money.
- Risk & Reward: The options trading is risky as well as a profitable trade option.
- Options Calculator: In order to execute a successful trade, the investor needs to calculate the value of the option accurately. For that, they may check the options calculator.
These are some guidelines regarding the Basics of Options Trading. The article Basics of Options Trading have every detail about options.