There are different sets of assets, securities, and contracts that are widely used for trading activities. And Options stand top when talking about some flexible and volatile contracts for trading. While options seem quite complex and hard to beginners but actually is easy to understand. As they simply fluctuate based on the momentum of their Underlying assets or the assets from which they are derived out.
Example: The current price of the Reliance industries option (PE/CE) will depend on the performance of the Reliance industries share price. If you have bought 1 lot for Rs.10,000 then your investment value is most likely to appreciate if the share price of Reliance industries moves in an upward direction and vice-versa.
In this article, we will be covering in-depth information about Options trading, the advantages of Options trading, and get an essence of how to do options trading?
Options Trading
Options are a type of derivates that are traded in the stock exchange. They simply rely on their underlying asset for deriving the contract price. Before trying on options one must be very clear that options are a type of contract and the buyers/sellers will not get any form of ownership, unlike stocks. One can bet as a buyer or seller to an option based on one's analysis.
Options trading involves high risk and return because they are quite volatile in nature. Even a small change in the market value of underlying securities can elevate or plunge your investment based on your position type. Let us bring in more clarity by taking an illustration:
By analyzing the chart pattern of a specific stock you jumped to a point that the share price of this specific scrip will increase. In lieu of this, you buy the option contract of that stock. But, due to some uncertain news investors started selling their shares that directly impacted the value of your contract. Now it will also start to decline its value and you end up making a loss.
There are 2 types of Options Contract, one is the Call option (CE) and the other is Put option (PE). When you are buying a contract based on the calculations that the value of the underlying asset will increase and in turn, you will be benefitted from an increased value then you will buy the Call option.
While when you buy a contract for getting rewarded from a decline in the value of underlying security, you go for the Put option.
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Terms an Options trader must know
1. Expiry date- Since options is a type of contract so it comes with a final due date post which it gets expire or no more exist. Mostly the duration of an options contact range between 1 week to 3 months. Example: If you are buying a 3 months contract in July 2021 then it will come with a due date of October 2021. Additionally, the longer the contract, the higher will be the premium price.
2. Premium price- Premium price is the price that a buyer will pay while getting into a contract. Or simply say the amount paid by the buyer for buying a contract. The premium paid will depend on the spot price, momentum of the underlying asset, and the length of the expiry date.
3. Spot price and Strike price - Spot price is the moving or changing current price of the underlying security. While Strike price is the rigid price that is pre-determined and tracked by the traders.
4. Lot size- There is no mandate on buying a few units or hundreds of stock quantities while in options the investors have to buy a lot size. A lot simply means a bundle that can be of 50 units or more. For example, The spot price of an options contract is Rs. 100 and it comes with a lot of 50 units, then you have to pay Rs. 5000 for buying that contract.
Advantages of Options trading
1. Hedging- If you are into the stock market then you might have heard of this term, many a time. Hedging is a strategy of minimizing the risk that is associated while you invest. It reduces the level of risk that is attached to a future trend.
Example: You are owning a certain quantity of equity in your investment portfolio and you want to safeguard your investment. So, you will buy the Put option of the same security. And if the price of your investment goes down then you will be able to recover the loss from options contract.
2. Higher returns- It is said that higher risk brings high returns but you are not supposed to take a risk all the time instead you can enter into an options contract based on your risk appetite.
Also, the premium that you pay is quite less amount as compared with delivery of shares. Eventually, the profits you make are also quite high in relation to the profit you would have made from equity.
3. Strategic advantage- This is one of the best advantages of options trading if you are entering with a strategy. Developing a strategy shield you from excessive losses that are associated with trading activities.
Example: One can buy Call and put options contract at the same time and add more of a winning contract to generate more profits.
Take away
From the article above we captured in-depth knowledge about options trading and later we derived the types of contracts in Options. That are Call options and Put options.
Then we read about the advantages of options trading that include Hedging, higher returns, and strategic advantages. Although, there are many benefits associated with it but we limelight the prime ones.
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