What are Put options trading and Call options trading in the share market? Interestingly, there are some investors actively involved in Put Option and Call Options Trading.
Let us understand what is options trading and the difference between call options and put options and how it works in the stock market in India. There are two types of options trading in India. They are
1. Put Option 2. Call option
Options are often used as hedge against the investments you made in the stock market.
What Is a Call Option?
Call Option is basically a financial contract that gives the buyer the right, but not the obligation to buy the underlying, at the exercise price ( strike price), within a specified time. Here, the stock, bond, or commodity is the underlying security. A call option buyer gets profit when the stock, bond, or commodity price increases.
What is Put Option?
Put Option gives the buyer of option the right, but not the obligation to sell the underlying security at the exercise price(strike price), within a specified time. unlike call option, put option price increases as the underlying’s price decreases. They lose value as the underlying increases in price.
There are few key factors which need to be understand to trade in Options.
- Strike price
- Expiration date (contract date)
- Option premium
- In the money
- At the money
- Out of the money
What is the strike price in options trading?
Option trading contracts are sold or bought on the strike price. The strike price of an option is the price at which a put or call option can be exercised. Picking the right strike price is one of the important factors of options trading. For the Call option holder, the strike price is where they will have to purchase the security, and for the Put option holder, the strike price is where they will have to sell the security.
What is the expiration date in Options trading?
The expiration date or settlement date is very important in options trading. As we discussed, every contract has a specific date of expiration. On this date, option contract owners can choose to exercise their option by closing their position either with profit or loss. If the contract is not exercised, on the specified expiration date, then the contract will become worthless.
Broadly speaking option premium is the current market price of an option contract of the security. The seller (also called Option writer) is going to get this premium amount from the buyer of that security contract. Again, these option premium is based on 3 factors of the underlying asset.
- Intrinsic Value: There are many ways often used to arrive at the intrinsic value of the security. To make it simple, intrinsic value is nothing but the difference between the current price of a security and the strike price of the option.
- Time Value: Investors in options always calculate the time value of the options contracts. Based on the contract they have exercised, time decay will bring profit or loss to the option traders. Time value is the difference between the options premium and the intrinsic value. Time Value = Option Premium – Intrinsic Value.
- Implied Volatility: Expected volatility of stock during the period of options contract represents the implied volatility. If demand for an option increases implied volatility also will rise. The stocks which have high levels of volatility will have high option premiums.
What is In the money options trading (ITM)
When the intrinsic value of an option is more than the market price of a security, it is said to be In The Money.
- In the money call option gives the opportunity to the option holder to purchase the security below its current market price. That means, In the money call option market price is below the strike price.
- At the same time, In the money put option gives the opportunity to the option holder to sell the security above its current market price.
What is At the money Options trading (ATM)
When the option’s strike price is same as the current market price of underlying security , such circumstances, we say At the Money in Options Trading.
At the money (ATM) is a situation where an option’s strike price is identical to the current market price of the underlying security. … For example, if XYZ stock is trading at Rs.75, then the XYZ 75 call option is ATM and so is the XYZ 75 put option
What is Out of the money options trading?
Out of the money options trading has only an extrinsic value. When compared to In the Money and At the Money option, a premium of Out of the money is less expensive. Underlying security call option OTM’s current price will be below the strike price of the call. In put option, OTM of the security current price is above the put’s strike price.
Option Price affect based on different factors. To measure the factors, option traders use Option Greeks. Delta, Gamma, Vega and Theta are collectively known as Option Greeks. Option greeks helps the option traders to understand the potential risk reward of an option position.
- Delta measures the change in the option premium price with respect to the price underlying security. While entering options trading, one should have realistic expectations about the movement of the price of the options or stock you trade. Delta in call Option is between 0 and 1. This means, if the call option delta is Rs. .50 and the stock price goes up by Re. 1, the call price also moves up by Rs. 0.5. Delta in Call option is always positive. In put option, if the stock price goes up, the price of the put option will go down unlike the call option. Put options have a negative delta.
- Theta gives you information about how the price will change as time value passes. Theta or time decay always favors the option seller.
- Gamma is a percentage of change in options delta based on a single-point move in the options delta price.
- Vega measures the sensitivity of an option contract to implied volatility.
Often you might have heard about 2 words in trading. i.e., Long and Short. What does this means ?
Long — If an Investor goes ‘long’ in a security, he expects the price of the security to rise.
Short — Similarly, when an investor goes ‘short’ in a security, he expects the price of the security to fall.
What is Volatility?
While you are trading with stocks or Options, one has to keep an eye on the volatility of the stock/option price. Traders always refer to historical volatility and implied volatility. When we say historical, it is 1 year or 52 weeks of price volatility on a day-to-day basis. Stock prices move up and down based on the news publications about the stock. In such circumstances, traders change their investing patterns on such stocks or options.
How to write (sell) covered calls
A covered call is nothing but you are selling the right to purchase a stock that you already have at a specific price with a specific time frame. The option lot size differs with each stock. You must own the shares of one lot size to cover your option writing on that stock. By doing this, you are safe if the stock price falls.
How to choose stock for option trading ?
Check for the fundamental of the stock you are planning to invest.
Choose the stock which has the liquidity
Choose a Low to Medium priced stock
Check for any corporate actions
Go through the historical data and present movement trends in the stock.
What about option trading for beginners
As a beginner in options trading, one needs to determine their risk tolerance level. Each individual risk tolerance level is different based on their age, income, and investment goal. They can be
- Very aggressive
- Very conservative
It is always suggested to invest in stocks and learn the option trading by hedging the stocks you own. Understand the methodology and implications of greeks in option trading. It is safe to start options trading with the Index option till you get the idea of greeks. Then slowly move to stock options. To safeguard yourselves, start with one lot to minimize your exposure to risk. Further, trade with any one type of option (either call option or put option) initially. Then slowly move on to the other.
Investors often jump into options trading before understanding the options strategies. It is required to understand the option strategies to minimise the risk and to safeguard your investment. Follow the market with patience, knowledge and discipline to understand the movement.
To become a successful options trader, you should develop certain skill set, interest , risk taking capacity and required money to invest in.
What are the Put options and Call Options in the share market? For a detailed explanation refer to this.
Read about IPO here.
What do you think, whether you can make money in the stock market. Read here.
Also know about Commodity trading here