For instance, Nifty 50 options let traders make predictions about the future course of this benchmark stock index, which is sometimes used as a proxy for the whole Indian stock market.

Options could seem a little paradoxical at first, but they aren’t as difficult as they look. All you need to know to comprehend alternatives is a few essential terms:

The derivative. Options are classified as derivatives as their value is derived from another asset. Consider stock options, where the option contract’s value is determined by the price of a certain stock.
Put and call options. A put option enables you to sell a security at a future date and price, whereas a call option allows you to purchase a security by a given date at a predetermined price.
The expiration date and the strike price. A striking price is that preset amount that was previously indicated. Traders may execute an option at its strike price up until the option contract’s expiration date.
Superior. An option’s purchase price, known as a premium, is determined by taking into account the price and values of the underlying securities.
both external and intrinsic value. The difference between the strike price of an option contract and the current value of the underlying asset is known as intrinsic value. Extrinsic value refers to variables that impact the premium but are not taken into account in intrinsic value, such as the option’s duration.
Both in and out of the money. An option is considered to be in-the-money (profitable) or out-of-the-money (unprofitable) based on the price of the underlying security and the amount of time till expiration.

How to Price Options

Let’s use an example to help clarify all of this lingo. Think of a stock that is now selling for INR 100 a share. This is how, depending on the strike price, the premiums—or prices—work for various options.

Call Option Strike Price PremiumPut Option Premium: Maximum INR 90, Lowest INR 95, Maximum INR 100, Current Price INR 105, Minimum INR 110, Highest
When you trade options, you have the opportunity to purchase this imaginary stock—called call options—or sell it—put options—at the specified strike price by the expiration date by paying a premium upfront.

Since the options contract allows you to purchase the stock at a lower price than what it is now trading for, call options with a lower strike price have more intrinsic value. Your call options are in-the-money and you can purchase the stock at a discount if the price of the stock stays at INR 100.

On the other hand, put options with a higher strike price have more intrinsic value since the contract enables you to sell the shares for more than its current market value. If the stock continues at INR 100, your options are still in the money, but you can sell it at a higher strike price, like INR 110.

How to Trade Options

You can use a variety of options trading techniques, ranging from simple, uncomplicated transactions to complex, multi-step systems. In general though, trading call options allows you to place a bet on prices that are rising, while trading put options allows you to place a bet on prices that are decreasing.

Investors that hold options contracts have the option to purchase or sell a minimum of 100 shares of stock or other assets. In the event that a deal isn’t lucrative, options aren’t required to be exercised. An investor’s sole potential loss is the premium they paid for the contracts if they choose not to exercise their options. Because of this, speculating on a wide variety of asset classes may be done relatively cheaply through options trading.

With option trading, you can make predictions about:

Whether the price of an asset will increase or decrease from where it is now.
How much the price of an asset will increase or decrease.
When will these price adjustments take place?
In order to break even on call and put options, the price of the underlying asset must increase or decrease by the amount of rupees equal to the premium paid plus the strike price. This is how you make money:

Callable options. You can sell the call option (also known as closing your position) and receive the difference between the premium you paid and the current premium once the price of the underlying asset has surpassed the break-even point. As an alternative, you can use the option to purchase the underlying asset at the strike price that has been decided upon.
Put choices in. You can sell the options contract, closing your position, and collecting the difference between the premium you paid and the current premium once the asset’s price drops below the break-even point. As an alternative, you can sell the underlying asset at the agreed-upon strike price by exercising the option.
You can simply let the contract expire if the asset’s price moves against your expectations for a call or put option; however, your losses will be equal to the option’s purchase price, which includes the premium and any related trading expenses.

When seasoned traders pair up two or more calls or puts with various strike prices or expiration dates, options trading techniques can get extremely complex.

Pros of Options Trading

Trading options blends flexibility and specificity. To lock in the price they think an asset will reach over a given period of time, traders must select a precise strike price and expiration date. They are free to see how things pan out during that period, though, and they are not required to execute a deal if they are mistaken.

Options traders aim to restrict their exposure to a particular asset for a shorter duration, as options contracts have an expiration date that can vary from a few days to many months. To decide whether to exercise an option or stay in the money, options traders must constantly watch the price of the underlying asset.

Trading options is a desirable hedging strategy as well. If you hold stock in a company, for instance, you may purchase put options to lessen your potential losses in the event that the stock price drops. This is one of the reasons why options for large market benchmarks, such as the Nifty 50, are frequently utilized as a hedge against short-term market falls.

Because of this, options trading can be an affordable, low-risk alternative to place a speculative wager with the possibility of large profits and a more methodical approach to investing.

Cons of Options Trading

Not everyone is a good fit for options trading, especially for those who would rather take a hands-off approach to investment. Options trading basically requires you to make three decisions: direction, price, and time. This makes the investing process more complicated than some people would want.

There’s another barrier to options trading, not present in stock trading: Brokers are required by the Securities and Exchange Board of India (SEBI) to authorize customer accounts for options trading only upon the completion of an options trading agreement. This is how your knowledge of options trading and the risks involved is evaluated.

Setting up price alerts and monitoring the market closely will help you benefit from options trading by allowing you to know when a trade is beneficial. Additionally, you should be aware of the risks and trading costs associated with different options techniques. Fees for trading equities and exchange-traded funds (ETFs) have been eliminated by many brokers, but they still apply to options trading.

When you purchase or sell options, commissions might vary from a set charge to a per-contract price depending on how much you trade. The profitability of an options strategy must therefore be taken into account by options traders.

Finally, you may experience short-term capital gains from options transactions due to their naturally shorter timeframe. In India, investments kept for less than a year are subject to regular income tax, which can reach 15% depending on the RBI income tax level. In contrast, investments held for more than a year are subject to a reduced long-term capital gains rate.

How to Get Into Options Trading

Prior to delving into options trading, it is advisable to have a very firm grasp of trading. Next, you should describe your investment goals, including growth, income generation, capital preservation, and speculation. There can be further requirements from your broker, such revealing your net worth or the kinds of options contracts you plan to trade.

SEE ALSO: Essential Tools And Techniques For Seasoned Investors

By Linh Ho

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