Option Trading – Basics and Strategies
What is an Option in Stock Market?
Option is a financial instrument or security, which is used for hedging or mitigating the risk involved in investment activities in financial markets.
Basically option is a derivative product. In simple terms it is contract between two parties to exchange an asset, in future date at predefined price and quantity by collection of upfront token amount or premium
Example:
Mr. X approaches “Y” to buy a mobile at Rs. 10,000 after a month. So Mr.”X” pays a token amount or premium Rs. 100 so that whatever the price of option after a month, Mr.”Y” is obliged to sell the mobile at Rs.10,000 to Mr.X.
Mr. X approaches “Y” to buy a mobile at Rs. 10,000 after a month. So Mr.”X” pays a token amount or premium Rs. 100 so that whatever the price of option after a month, Mr.”Y” is obliged to sell the mobile at Rs.10,000 to Mr.X.
Generally retail investors use options for trading purpose and Financial institutes use them for hedging purpose. These are high risky products, option buyers have highest chance of loosing money than option shorter(Sellers).
One should definitely understand that Futures and Options are not Investment or trading products they are hedging instruments. Understand the risk involved in trading futures and options before you transact.
Option Basics:
Strike Price: –
The stated price per share for which underlying stock may be purchased (for a call) or sold (for a put) by option holder upon exercise of the option contract.
The stated price per share for which underlying stock may be purchased (for a call) or sold (for a put) by option holder upon exercise of the option contract.
There are three types of strike price:
In the money, ITM: It is an option that would lead to positive cash flows to the holder if it was exercised immediately. A call option is ITM when spot price is greater than strike price. If the difference is huge it is called deep in the money.
At the money, ATM: It will lead to zero cash flow if exercised immediately. Option is at the money if strike price is equal to spot price.
Out the money, OTM: It will lead no cash flow if exercised immediately. In case of call option if strike price is greater than spot price than it is OTM. Whereas in case of put option if strike price is less than spot price it is OTM
Contract Expiration Date: –
The date on which option contract expires is expiration date or the maturity date. It is the last day on which option can be exercised. Active Options normally have a monthly or quarterly expiration cycle.
The date on which option contract expires is expiration date or the maturity date. It is the last day on which option can be exercised. Active Options normally have a monthly or quarterly expiration cycle.
Option Price/Premium:
Option price is the price, which the option buyer pays to the option seller. It is also referred to as option premium. The premium depends on various factors like Strike price, Stock price, Expiration date, Volatility, Interest rate. The buyer pays premium to seller, seller has the obligation to fulfil the option terms when assigned to him.
Option price is the price, which the option buyer pays to the option seller. It is also referred to as option premium. The premium depends on various factors like Strike price, Stock price, Expiration date, Volatility, Interest rate. The buyer pays premium to seller, seller has the obligation to fulfil the option terms when assigned to him.
Types of options:
Call Options: Buyer has the right but not the obligation to buy the underlying stock.
Put Options: Buyer has the right but not the obligation to sell the underlying stock.
Different styles of options:
- European Style – Can be exercised only on a expiry date
- American Style – Can be exercised any time prior to expiry date
- Exotic – Bermudan, Asian, Binary, Barrier etc. The exoticness of the Option can depend on price or time.
Watch our YouTube videos at https://www.youtube.com/c/MarketSecrets to learn how to trade options.
Link to download the PPT used in the option training video in our YouTube channel.
Need help in becoming a professional and an independent trader? Then, Contact us at https://t.me/MarketSecretsTeam through telegram or Email us admin@marketsecrets.in
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