What are the options?
An option is a contract, traded in the stock market just like stocks are, but how to trade options where they give you the right to buy or sell the underlying stock at a certain fixed price. Options are having 2 kinds of contracts call and put options to learn more about options terminologies to understand better about options trading.
Basic Options Trading Terminology
Sometimes it is difficult to define options trading terminologies so we simplified things a little so they’d be easier to understand.
Here is a list of the terminology you need to know about options trading:
- CALL OPTION: A call option gives the buyer the right to buy shares at a fixed price (strike price) before a specified date (expiration date)
- PUT OPTION: A put option gives the buyer the right to sell shares at a fixed price (strike price) before a specified date (expiration date)
- PREMIUM: The price of an option contract paid is called a premium.
- STRIKE PRICE: The strike price is the price per share at which the holder can purchase (for call options) or sell (for put options) the underlying stock/INDEX.
- LONG: Being “long” in an option means to have buy [call/put] and hold it
- SHORT: Being “short” in an option means to sell [call/put] and hold it. (A short position is carried as a negative on a statement and must be purchased later to close it.)
- EXERCISE: If exercising, calls owners will buy the underlying stock, while put owners will sell the underlying stock under the terms set by the option contract.
- EXPIRATION DATE: The expiration date is the last day on which the option may be exercised. It can be monthly or weekly expiry contracts.
- HEDGING: A risk management strategy used in limiting or offsetting the probability of loss from fluctuations in the prices of stocks or Indices [Nifty/Bank Nifty]
- INTRINSIC VALUE: The intrinsic value of an option is the amount of profit that can be obtained if the option is exercised at that moment and the stock either purchased (for calls) or sold (for puts) at the current market price.
- TIME VALUE: Time value is the period by which an option’s contract will exceed its intrinsic value.
- TIME DECAY: As each option have an expiration date, they lose time value erodes to zero by expiration. This erosion of premium is known as time decay.
Is options trading good for beginners?
As a beginner, you need to first start from the very basics where You need to learn the concepts of volume, trend and market sentiment of Index or stocks. Then, you can learn easily how to trade derivative contracts for INDEX Future and options.
Trading in derivatives for a beginner is like learning to run before you learn to walk.
These are the few reasons why options trading is not good for beginners:
- As futures and options are leveraged products most beginners don’t know how to trade leverage products the right way
- Options work very differently from stocks and futures as time decay and implied volatility are also at work here apart from the direction of the stock
- Lack of knowledge about how futures and options markets work in general.
- Not willing to invest in learning the basics like training, books, mentoring.
Many people only realise this when they have lost a lot of money.
Futures & options contracts designed to protect your Investments by creating hedges strategies on your portfolio. These are heavily traded and it’s even bigger than the actual market.
Why Trade Options? [Advantages and Disadvantage]
The options market is one of the most versatile trading instruments available to trade. They can be traded on a variety of underlying instruments such as stocks, stock indexes, currencies, futures, exchange-traded funds, commodities, and bonds.
The wonderful thing is that options trading concept is, it works the same for all Trading Instrument. So once you had understood how to trade option, you can be able to trade options in any underlying instruments whether it is stocks or Commodities.
Advantages of options trading:
- The price of buying an option contract (the premium plus the trading commission) is very less when compared to what an investor would have to pay to buy shares.
- If your assumptions about the time frame and direction of a stock’s trajectory are incorrect, your losses are limited to whatever you paid for the contract
- you can Make good money based on a relatively small movement in the stock/ Index
- Some options Hedging strategies enable you to generate a monthly passive source of income.
- Learn about options strategies that give the options trader the ability to make money from any market conditions whether the market is up, down or sideways with limited risk exposure and potentially good profits.
Disadvantages of options
- Unlike stock where you can hold on to it for many years or even passes on to your children, all options have an expiration date.
- If you hold onto a trade that goes against you and the options are out of money at the expiration date, you may lose that money you invested in the options.
- The reward and danger of leverage is especially powerful when you are selling naked calls or puts or entering into any unlimited risk option strategies.
How to trade options, where do I start trading?
I have traded for more than 10 years in hedge funds & Many big financial institutions in my life on derivatives Segment. I will summarize everything that I learned from options trading in a few points:
- Trading is not gambling If you follow a systematic approach.
- Trading is purely based on psychology & mindset of a trader
- Learn to preserve your capital for good trades with a high probability of success
- You need to analyze each trade you do & maintain a track to improve trading
list the things which are required for you to start trading options:
- Basic laptop with at least 4 GB of RAM or a good Smartphone with 4 GB ram
- You need to speed internet connection to stream the live price movements
- You will need trading and Demant account for analyzing charts, orders & positions
- Open a trading account with discount brokers to get started
- You need a bank account with at least 6 months of active transactions.
The next question will be the right knowledge of trading options. To start trading in options you need to ask yourself the following questions?
Do I Know the complete technical Analysis on how to trade options?
- Knowledge of Technical Analysis is a must for any kind of trader. Learn basics on Technical Analysis from Trade Psychology.
DO I Know which trading Instrument to trade that gives better ROI?
- You need to decide what kind of an option you want to trade is it an index option is it a stock option or you will trade in futures.
How much money will you put in your trading account?
How much of a loss are you willing to take if the trade goes in the wrong direction?
How to open options trading account?
Zerodha is one of the leading discount brokers in India for trading in Stock, Currency Derivative and Commodity Market With a High volume of Trader database. It also charges a brokerage of 0.01 paisa which is lowest broker.
Documents required in Account opening Process:
- Copy of Pan Card
- Copy of Adhar Card
- Passport Size Photo
- Bank statement
- Copy of Address Proof
- Your Signature
Read more about Zerodha Discount Brokerage features here
How much money you need to start trading in options?
The minimum money required for buying an Option would be the premium paid in addition to brokerage and other charges.
Options are available in lot sizes which varies from stock to stock. So, you would need to pay a premium for 1 lot minimum, whatever be the number of shares in it.
Let take the example of an options chain data for week 6-Nov-18 expiry
As on options chain can see on the left-hand side there are call options and right-hand side there are put options. If you are willing to buy any options then you have to pay the money for “number of lots * premium “.
e.g. Bank nifty 25,400 call option current premium is 166.1 so you have to pay
166.1 *20 = 3,322 rupees to buy this options contract
But if you are on the selling side you have to pay more because sellers have to pay more margin,
So if you are selling one lot of Bank nifty at 39.05 premium then for Intraday (Rs. 15,240) and for Delivery you have to pay (Rs. 40468 ).
Another factor you need to consider is brokerage charges where discount brokerage like Upstox, Zerodha charge a fix brokerage Rs 20 for any number of lots where SBI, HDFC securities have more charges on option and future.
So if you want to save money in brokerage in F & O please go with a discount broker like Zerodha or Upstox
How much money you can make trading options?
Let’s assume your goal is to make 10% a month and your max loss is 10%.
Assuming you have a 1,00,000 in your account, you can invest at 50%-50k. You start trading with 50% of your capital and keep the rest for adjustments for better returns
If you make 10% a month, that’s 5k a month, which is 60k a year and that would be 60% on the entire account.
In some months you will make fewer profits also you may event lose, so as per me you can make anywhere between 30–35% to be realistic with hedging in Nifty & Bank Nifty options
I employ large capital to sell options i.e. be a call or put writer. This strategy helps me to generate a guaranteed return of 3–5 % every month on my capital employed, also I diversity my hedging capital with Nifty & Bank Nifty options to generate consistent income every month.
Here is my trading performance for the last 2 years trading INDEX Future & options.
My Trading Perfomance for past 2 years in Index Future and optionsCLick here
Also, watch this video on how I am able to generate consistent income trading Nifty & Bank Nifty weekly options
So, reading this article you can be able to decide, How to trade options in India?
Let us know what is your experience in trading options, please mention in comments below,
I have a Free course on Trading Psychology for you, please check below.