Options Trading

1. Introduction to Options Trading
Options trading is one of the most powerful tools in financial markets. Unlike traditional stock trading, where you buy and sell shares directly, options give you the right but not the obligation to buy or sell an asset at a predetermined price before a specific date. This flexibility allows traders to hedge risks, generate income, and speculate on price movements with limited capital.

In recent years, options trading has seen a surge in popularity, especially among retail investors. With the growth of online trading platforms and educational resources, more traders are exploring this complex yet rewarding field.

2. What Is an Option?
An option is a financial derivative contract. It derives its value from an underlying asset—commonly a stock, index, ETF, or commodity.

There are two types of options:

Call Option: Gives the holder the right to buy the asset at a fixed price (strike price) before or on the expiry date.

Put Option: Gives the holder the right to sell the asset at a fixed price before or on the expiry date.

Key Terms to Know:
Strike Price: The price at which the option can be exercised.

Premium: The price paid to purchase the option.

Expiration Date: The last date on which the option can be exercised.

Underlying Asset: The financial instrument (like a stock) the option is based on.

In the Money (ITM): When exercising the option would be profitable.

Out of the Money (OTM): When exercising the option would not be profitable.

At the Money (ATM): When the strike price is equal to the market price.

3. How Options Work
Let’s break this down with an example.

Call Option Example:
You buy a call option on Stock A with a strike price of ₹100, paying a premium of ₹5. If the stock price rises to ₹120, you can buy it for ₹100 and sell it for ₹120—earning a ₹20 profit per share, minus the ₹5 premium, netting ₹15.

If the stock stays below ₹100, you simply let the option expire. Your loss is limited to the ₹5 premium.

Put Option Example:
You buy a put option on Stock A with a strike price of ₹100, paying a ₹5 premium. If the stock falls to ₹80, you can sell it for ₹100—earning ₹20, minus ₹5 premium = ₹15 profit.

If the stock stays above ₹100, the option expires worthless. Again, your loss is limited to ₹5.

4. Why Trade Options?
A. Leverage
Options require a smaller initial investment compared to buying stocks, but they can offer significant returns.

B. Risk Management (Hedging)
Options can hedge against downside risk. For example, if you own shares, buying a put option can protect you against losses if the price falls.

C. Income Generation
Writing (selling) options like covered calls can generate consistent income.

D. Strategic Flexibility
You can profit in bullish, bearish, or neutral markets using different strategies.

5. Types of Option Traders
1. Speculators
They aim to profit from market direction using options. Their goal is capital gain.

2. Hedgers
They use options to protect investments from unfavorable price movements.

3. Income Traders
They sell options to earn premium income.

6. Option Trading Strategies
1. Basic Strategies
A. Buying Calls (Bullish)
Used when you expect the stock to rise.

B. Buying Puts (Bearish)
Used when expecting a stock to fall.

C. Covered Call (Neutral to Bullish)
Own the stock and sell a call option. Earn premium while holding the stock.

D. Protective Put (Insurance)
Own the stock and buy a put option to limit losses.

2. Intermediate Strategies
A. Vertical Spreads
Buying and selling options of the same type (call or put) with different strike prices.

Bull Call Spread: Buy a lower strike call, sell a higher strike call.

Bear Put Spread: Buy a higher strike put, sell a lower strike put.

B. Iron Condor (Neutral)
Sell OTM put and call options, buy further OTM put and call to limit risk. Profit if the stock stays within a range.

C. Straddle (Volatility)
Buy a call and a put at the same strike price. Profits from big price movement in either direction.

7. The Greeks: Measuring Risk
Options prices are sensitive to many factors. The "Greeks" are key metrics to assess these risks.

1. Delta
Measures the change in option price with respect to the underlying asset’s price.

Call delta ranges from 0 to 1.

Put delta ranges from -1 to 0.

2. Gamma
Measures the rate of change of delta. Important for managing large price swings.

3. Theta
Measures time decay. As expiry approaches, the option loses value (especially OTM options).

4. Vega
Measures sensitivity to volatility. Higher volatility = higher premium.

5. Rho
Measures sensitivity to interest rate changes.

8. Options Expiry & Settlement
In Indian markets (like NSE), stock options are European-style, meaning they can only be exercised on the expiration date. Index options are cash-settled.

Options expire on the last Thursday of every month (weekly options on Thursday each week). After expiry, worthless options are removed from your account.

9. Option Trading in India (NSE)
Popular Instruments:
Nifty 50 Options

Bank Nifty Options

Stock Options (like Reliance, HDFC Bank, Infosys)

FINNIFTY, MIDCPNIFTY

Lot Sizes:
Each option contract has a fixed lot size. For example, Nifty has a lot size of 50.

Margins:
If you buy options, you pay only the premium. But selling options requires high margins (due to unlimited risk).

10. Risks in Options Trading
While options are powerful, they carry specific risks:

1. Time Decay (Theta)
OTM options lose value fast as expiry nears.

2. Volatility Crush
A sudden drop in volatility (like post-earnings) can cause option premiums to collapse.

3. Illiquidity
Some stock options may have low volumes, making them harder to exit.

4. Assignment Risk
If you’ve sold options, especially ITM, you may be assigned early (in American-style options).

5. Unlimited Loss for Sellers
Option writers (sellers) face potentially unlimited loss (especially naked calls or puts).


Conclusion: Is Options Trading Right for You?
Options trading offers huge potential for profits, flexibility, and risk management. But it is not gambling—it’s a strategic and disciplined skill.

Start small. Learn the concepts. Practice on paper or use virtual trading apps. Focus on risk first, reward later.

Used correctly, options can transform your trading game. Used poorly, they can wipe out your capital.