Generally, there is a thought that trading in the stock market requires more money. To break this concept, the ideology of options was introduced. In India, Options trading was introduced in the year 2001. Options trading is a very popular trading method because of its handsome return. Let’s discuss option trading in this article.
Dear Reader, Welcome to SimplyRead! Yes, here things are So Simple!
WHAT IS OPTION TRADING?
Options trading allows a trader to trade stocks at a discounted price. Moreover, the discounted price is mentioned as Option Premium. An Option has an expiry date at which the contract ends for the particular period. The trader can buy and sell options as much as needed during this contract. Click here to read about trading in the stock market.
BREAK INTO PIECES
To understand practically, let’s break up the components of options. For this, let’s take an example of the company named “HCL technologies”. We know that options are bought and sold at a predetermined price. This option is represented as HCLTECH Aug 1000CE
TERMINOLOGIES
There are various terminologies involved in Options trading. Firstly, Let’s understand the basic terminologies involved in options trading.
1.PREMIUM
Premium is nothing but the option price. Moreover, It can be defined as the price at which the option can be bought and sold. Further, the premium is the discounted price of the stock for the Stock option. Stock Premium is the difference between the Strike price and the current market price of the stock. Similar to stock premium, Index premium follows the same. Sometimes, it is also represented as LTP (Last Traded Price).
![\[ \boxed{Premium =|Strike\hspace{1}Price - Market\hspace{1}Price|} \]](https://simplyread.co.in/wp-content/ql-cache/quicklatex.com-8b8281dee77f80e58d0bb119f880c0aa_l3.png "Rendered by QuickLaTeX.com")
2.STRIKE PRICE
The strike price is the predetermined price of the stock/index. For example, If I predict the stock price of HCLTECH will hit ₹1000, then ₹1000 is the strike price here. Moreover, the strike price is the fixed price. usually, it will be whole numbers and not in decimals.
3.SPOT PRICE
Spot Price is the actual price of the stock or index. In other words, it is the stock price trading in the live market. For example, HCLTECH trades at ₹960 while writing this blog.
4.LOT
Lot is nothing but a fixed quantity of options. To be precise, the option can be bought only in lots and multiples. It cannot be bought in desired numbers such as 32qty. For example, the lot size of HCLTECH 1000 AUG CE is 700 qty. It means the minimum quantity which can be bought and sold is 700 and multiples of 700. To put it simply, A trader can buy and sell quantities of 700, 1400, 2100, etc.
5.EXPIRY
We all know what is expiry mean. Let’s say we are buying a biscuit pack. What we will see first? The expiry date or the shelf life of that biscuit. Likewise, options have an expiry date. For stock options, the expiry date will be monthly expiry whereas index options have both monthly and weekly expiry. All the trades should happen before the expiry date.
MONEYNESS
Moneyness is the position of the option in the live market. Moreover, it can be classified into two types. They are In-the-Money(ITM), At-the-Money(ATM), Out-of-the-Money(OTM). Let’s take an example as HCLTECH which has a current price of ₹956.
1.ITM
ITM or In-the-Money is the option position at which the strike price is below the spot price. It means the strike price already has crossed the spot price. For example, ITM for HCLTECH is the strike price which is below the current price of ₹956.
2.ATM
ATM or At-the-Money is the option position at which the strike price is exactly at the spot price. For example, ATM for HCLTECH is the strike price which is ₹956.
3.OTM
OTM or Out-of-the-Money is the option position at which the strike price is above the spot price. Moreover, OTM is far away from the spot price, and the strike price has not crossed it yet. For example, OTM for HCLTECH is the strike price that is above ₹956.
The below table shows the differences between the three types.
| ITM | ATM | OTM |
|---|---|---|
| More premium | Moderate Premium | Less Premium |
| High risk; high reward | Moderate risk; Moderate reward | Low risk; Low reward |
| Winning probability high | Winning probability moderate | Winning probability low |
Link to NSE OptionChain: https://www.nseindia.com/option-chain
The below option chain is market with ITM, OTM, and ATM for both put and call options. The yellow shaded rows represent ITM, White shades represent OTM and the center of the table represents ATM.
OPTION TYPES
The option can be of two types. They are Call Option and Put Option. Moreover, both are in contrast with each other. Let’s discuss them in brief.
CALL OPTION (CE)
Call Option or Call European option is bought predicting that the stock price will increase and reach the strike price. Moreover, the call option can be represented as CE. Further, “Call” represents calling upon the seller to buy the stock.
The price movement of CE is directly proportional to the stock price or index price
For example, Consider I have bought HCLTECH AUG 1000 CE. If the stock price of HCLTECH increases the CE option price will increase. In this situation, the trader makes profits. On the contrary, if the stock price decreases, the CE option price also decreases. As a result, the trades make a loss.
A call option can also be sold first followed by buying. Further, this is termed option selling. Option selling requires more funds to trade.
PUT OPTION (PE)
Put Option or Put European option is bought predicting that the stock price will fall and reach the strike price. Moreover, this is quite opposite of the Call option and represented as PE. “Put” is named considering putting the option for sale.
The price movement of PE is inversely proportional to the stock price or index price
For example, Consider I have bought HCLTECH AUG 900 PE. If the stock price of HCLTECH decreases the PE option price will increase. As a result, the trader makes profits. On the contrary, if the stock increases the trader will make a loss
Similar to the call option, the put option can also be sold first followed by buying. Further, this also needs more funds to make a trade.
TO WRAP THINGS UP!
Option buying requires less margin to make a trade when compared to option selling. Therefore, one can give try on buying the OTM option and gain knowledge of how it works.
Also, the Stock selection is important while doing stock options trade. Read about Qualitative, Quantitative, and technical analysis of the stock. Whereas, index options require technical analysis and market sentiment analysis.
Which stock or index you will make your first trade?
1 comment