What is an Option?

An option is one of the trading instruments in the stock market.

Option in the stock market is a contract that permits (but is not mandatory) a trader to buy or sell
an underlying stock or index at a predetermined price over a specific time.

A trader has to pay a small fee to buy these rights, and it is called the ‘premium’ of the option.
Call options (CE)

A call option (CE) is a contract that gives the trader the right to buy the shares of a security at a
specified price until it expires.
If a trader is buying CE, he expects the price of the security to go up so that he can make a profit
either by purchasing the shares at a predetermined lesser level or by selling the CE contract.

Buying CE is similar to buying insurance. If nothing happens and if you don’t claim any
insurance, the premium is of no use.

Put options (PE)

A put option (PE) is a contract that gives the trader the
right to sell the shares of a security at a specified price
until it expires.
If a trader is buying PE, he expects the price of the
security to go down so that he can make a profit either by
selling the shares at a predetermined higher level or by
selling the PE contract.
If the price of underlying security doesn’t go down (due
to either up move or sideways move), the PE premium
becomes zero at the end of expiry.

Long vs. Short options (buying and selling)

When a trader buys some shares anticipating the price
will go up in the future, it is called the ‘Long’ position.
In contrast, when a trader sells some shares first (without
having any position in the same stock), anticipating the
price will fall in futures, it is called a ‘Short’ position.
But unlike stocks, if a trader buys call options or put
options, it is recognized as a ‘Long’ position in options
(option buyer).
Suppose if a trader sells CE or PE (to pocket the
premium), it is recognized as a ‘Short’ position in options
(option seller or option writer).

Options Trading Jargons

Option Premium

The price that the buyer of the option gives to the option seller/writer.

Strike Price

The price at which the option buyer and option seller take the contract. It is also called
‘Exercised Price.’

For example, Banknifty is trading at 35265. A trader thinks it will go above 36000 in a week.
Hence, he will buy 36000 CE, assuming he will make money. Here, 36000 is one strike price
(call option example).

Expiry Date

The last date specified in the option contract is called the expiry date. It is also called an exercise
date.

After the expiry date, any options trader cannot exercise their options.

In-the-money (ITM), At-the-money (ATM), and Out-of-the-money (OTM)

What is In-The-Money (ITM) Option?

ITM option results in positive cash flow to the holder if it is exercised immediately.

For CE – when the spot price is higher than the strike price.

For PE – when the spot price is lower than the strike price.

What is At-The-Money (ATM) Option?

ATM option results in zero cash flow to the holder if it is exercised immediately.

For CE – when the spot price is equal to the strike price.

For PE – when the spot price is equal to the strike price.

What is Out-The-Money (OTM) Option?

OTM option results in negative cash flow to the holder if it is exercised immediately.

For CE – when the spot price is lower than the strike price.

For PE – when the spot price is higher than the strike price.

Options Greeks
Option Greeks are the different parameters that affect the premium of the options contract in
real-time.

It will help an option trader keep an eye on these parameters to reap the maximum benefits and
avoid significant losses with options trading.

Delta

It measures the rate of change of options premium concerning change in the underlying price.

Gamma

It is the change in option delta per unit change in the stock price. In simple words, it measures
the rate of change of Delta.

If the gamma is high, Delta is highly sensitive to option prices. Among OTM, ITM, and ATM
options, ATM options will have the highest gamma.

Theta

It measures the impact on the option premium concerning the time remaining for expiry.

Vega

It is the rate of change in the premium concerning change in the volatility. If the option’s vega is
high (either positive or negative), the option premium values are highly sensitive to any changes
in the volatility.

Rho

It measures the rate of change concerning interest rate.

Options Buying or Options Selling?

It is a never-ending hot debate in the trading community. The funny part is that the market needs
both option buyers and option sellers to run its show.

For example, only option buyers can’t buy their positions if the option sellers are absent and
vice-versa also holds true.

Traders should not waste time with these debates. If a trader makes money either with options
buying or options selling, he is right. If he loses money (either with options buying or options
selling), then he is wrong.

Option selling provides the highest winning probability as compared to option buying as the
‘time decay’ works for option sellers.

In theory, option selling comes with unlimited risk. However, a trader can manage this risk in
two ways: 1) by placing an SL buy order and 2) hedging.

Options Buying looks very attractive as it can give massive returns in quick time. But the time
decay works against options buyers and hence the winning probability is less with options
buying.
How to trade Options?

There are millions ways to trade with options. But all the methods fall under 3 broad categories:

1. Options Buying
2. Options Selling
3. Options Strategies
We will take a simple example to understand how to trade using options.. Please note, the below
trading ideas below are chosen for the explanation’s sake only.

Image - Daily Chart of Maruti Suzuki

The above image shows the daily chart of Maruti Suzuki.

Let us say there are two traders and both expect the price reach the anticipated target of 7600 by
end of this expiry.

Option Buyer

CMP - 6950

Number of days remaining for the expiry - 8 days

Image - Maruti 7600 CE premium value from NSE option chain

The above image shows the Maruti Suzuki Option Chain snapshot for the 7600 CE strike price
(target level) for the immediate month expiry.

One trader is an option buyer and he decides to buy 7600 CE at 17.30 (highlighted in yellow).

Maruti Suzuki 1 lot = 100 quantity

Hence, Rs.1,730 is needed to buy 1 lot of 7600 CE.

We assume this option buyer bought only 1 lot.

Assume the price closed at 7800, then he will make the below profit.

7800 (spot) – 7600 (strike) = 200

Subtract the premium paid, 200–17.3 = 182.7

So the profit is 182.7 x 100 (lot size) = Rs. 18,270

Image - Option Buying Trade Analysis through Opstra Define Edge

The above trade look very attractive as it generated over 1000% returns. But as I said earlier, the
winning probability in option buying is less.

If you look at the winning % probability through Opstra Define Edge tool, it is only 4.79%.

Hence, we can declare we can make big money with options buying if the price moves in our
direction, but the winning probability is less.

Option Seller

CMP - 6950

Number of days remaining for the expiry - 8 days

Option seller plans to sell PE as even he has similar views.

The above image shows the Maruti Suzuki Option Chain snapshot for the 7600 PE strike price
(target level) for the immediate month expiry.

Option Seller decides to sell 7600 PE at 448 (highlighted in yellow).

Maruti Suzuki 1 lot = 100 quantity

Approx Rs.250,000 is needed to sell 1 lot of 7600 PE.

We assume this option buyer sell only 1 lot.

Assume the price closed above 7600, then the premium becomes zero and the entire premium is
profit to him.

So the profit is 448 x 100 (lot size) = Rs. 44,800

17% ROI look small in this trade (as compared to options buying trade). But as I said earlier, the
winning probability in option selling is high.

If you look at the winning % probability through Opstra Define Edge tool, it is around 67.4%.

Hence, we can declare we can consistent money with options selling if the price moves in our
direction, and the winning probability is high.

Here, there is a possibility of losing big money if the trader fail to exit his option selling trade
and the price shows a big move in the opposite direction.

Options Stratagies

Traders can deploy many strategies involving buying/selling multiple legs of options contract.

Some of the famous options strategies are - Vertical spreads, Strangles, Straddles, Iron Condor,
etc.

One can read the below article to know these strategies in details

How to Trade Options? Learn Options Chain, Greeks, and Strategies | Profile Traders

An option is a contract that permits (but not mandatory) a trader to buy or sell a stock at a
predefined price over a specific time.
https://www.profiletraders.in/post/options-trading-for-beginners-india-2021

I hope this detailed explanation is helpful. If yes, please upvote and share it with your friends.

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