An option is a contract written by the seller, who shall convey to the customer the right but not the obligation to purchase, in respect of call options or put options, a certain asset at a specified exercise price in the future. The seller will collect a payment known as a premium from the customer in return for granting this option.
An investor can buy or sell stocks, ETFs, or other securities at a certain price and at a certain time with the help of options trading. This type of trade allows an investor to refrain from purchasing securities on a given date and at a certain price. For a better understanding of option trading and how it is done in India, let’s move ahead in this article.
What Is Option Trading?
An option is a contract granting an investor or trader the right, for a certain period, to trade stocks, exchange-traded funds, commodities, currencies, and benchmarks at a fixed price. The expiration date of the option contracts, typically on the last thursday in a calendar month, is fixed. The contract will expire, and the value will be zero once the specified expiration date is reached. Unlike futures, options do not bind buyers or sellers to sign the contract.
When you trade options on the stock market, you only own the shares once you have exercised the option. Options trading is different from the stock market due to this feature. You’ll be a part owner of the company when you buy shares. However, if you trade options, you merely indicate that you wish to own the company’s shares on a specified date and not own them.
Working Procedure Of Option Trading
Investors bullish on the market may purchase a call option when trading options, while those ready to bet that prices would decline might purchase a put option. Traders who purchase call options set a price at which they will purchase the shares later. As a buyer of that put option, the trader will instead determine the price at which he will sell the shares on any subsequent day.
In addition, traders may sell the call or put options and receive immediate premium payment if they wish to speculate on market declines or rises. However, they must perform their part of the contract when they’re selling. In the short term, traders can also buy calls and put options to make a profit. There are various combinations of options that can be bought and sold. Each combination is a strategy for option trading.
Advantages Of Option Trading
The benefits of options trading are as follows;
1. Great hedging tools:
Options are great, but you need to use them properly. Using options allows traders to minimise their downside risk in equity markets. For instance, a trader could buy put options to limit downside risk if they hold stock in the company and are worried about its price going down.
2. The potential for higher returns in short duration:
Compared to equity holdings, option investments are less likely to deliver more favourable returns over a shorter period. However, proper strategies will have to be used by the trader. The profit percentage is higher in options since traders spend fewer dollars on them, and their profits are nearly identical to those of stocks.
3. Cost efficient:
Options are cheaper than stocks because they are contracts for underlying assets and do not represent ownership. For instance, a trader will have to spend Rs 10,000 if he wants to buy 100 shares in a company for Rs 100 each. However, in the event of an option, they can purchase one contract for 100 shares at a rate of just Rs. 500. The traders may use the remaining money at their discretion, which gives them a high-profit margin on bets.
Option Trading Strategies
Every trader is required to know the following types of options trading strategies.
1. Bull option spread:
A bull option spread is a strategy in which a trader buys a call option and sells another option with a higher strike price than the first option.
2. Bull Put Spread:
In this case, a trader buys the put option and sells another one with a strike price higher than the first. If the price of a security increases, this trader will benefit.
3. Bear call spread:
This bearish trading method entails purchasing one call option and selling another with a lower strike price. Profit is only realised when an asset’s value decreases. Profits and losses are restricted by this method.
4. Bear put spread:
If traders think markets will decline moderately, they buy a put option and sell one at a lower strike price than the other. There are limits to losses and profits. When the price of an asset falls, there are profits.
Conclusion
In all types of markets, options trading is flexible and offers traders a wide range of opportunities. While options are high-risk investments, traders may choose to invest only in the basic strategies at low risk. The possibility of increasing total returns can be used by even an investor who does not hesitate to take risks. The best mobile trading app to do option trading is the Kotak App. Kotak Securities app is among the top-rated trading app, and it is highly recommended for newbies for safe and profitable trading.