What is Option Trading: Make profits with limited risk 🤑💵
What is option trading: Option Trading is a part of derivative trading & has unlimited profits with limited risk, if done with good knowledge & strategy. The Indian Secondary Stock Market is divided into two main parts: Equity and Derivatives. Derivatives again contain two main trading instruments known as Futures and Options, so option trading is a part of derivative trading and let’s explore more about this topic in detail.
I. Introduction to Option Trading
Options trading is a part of derivative trading instruments in the Stock Market, Options are introduced in the market to make traders or investors hedge their respective positions to avoid any uncertainty in the market but mainly traders use options to gain from short-term volatility in the stock market.
If these terms are new to you then do read the full post, we will cover all these topics in detail and don’t worry if it is going out of your head. Let’s dive in and understand what is option trading.
II. Types of Options
Options are divided into two types called as Call options and Put options, these types represent the bullishness and bearishness of the market.
- Call options Buying – Call options buyers have the right to buy the underlying assets on the day of expiry and are not obligated to do so when they are option buyers.
- Call options Selling – Call Options selling or writing makes the position holder obligated to provide (give back) underlying asset on the day of expiry, which makes the option selling riskier.
- Put options Buying – Put options buyers have the right to sell the underlying assets on the day of expiry and are not obligated to do so when they are option buyers.
- Put options Selling – Put Options selling or writing makes the position holder obligated to buy underlying assets on the day of expiry, which makes the option selling riskier.
III. What is Option Trading in India and how it works
Let’s understand the basis of option contracts in the Indian Stock Market Context, options have predefined sections known as option contracts. You need to have a good understanding of option contracts before you even think of taking any position in options.
Option Contracts have the following specifications: Let’s understand with an example of Banknifty. Let’s assume Banknifty is trading at 47000.
- Type: Call or put options
- Strike Price: Strike Price is a key specification that the stock exchange will decide. In Banknifty it will be 46700, 46800, 46900, 47000, 47100, 47200, 47300, 47400, etc.
- Expiry Date: Expiration dates are also predefined. In Banknifty there will be weekly expiry which expires every Wednesday and monthly expiry expires every Thursday of the last week of the month.
- Option Premium: Option Premiums are calculated using the Intrinsic value, time value of money and implied volatility.
We will cover these topics more in the upcoming post since its Option Price valuation is itself a big topic to cover. These option valuations can be done using the option calculator and you can find the option calculator in the tools section of the menu.
IV. Advantages of Options Trading in India
Options Trading is gaining popularity in Indian Stock Market and all options are traded through the Nation Stock Exchange of India. India became the second-largest marketplace in the world, in terms of volume traded in 2023 – 2024. Also, SEBI and NSE plan to extend derivative trading hours beyond normal market time.
What is Option Trading and its advantages:
Options Trading especially option buying makes it very attractive to a buyer since it has huge potential for unlimited profits and very limited loss and that makes option trading a popular choice among many trading communities.
If anyone uses options for hedging purpose or trade them with a defined option strategy then making a good return on options makes it a very advantageous instrument.
V. Risks Associated with Option Trading
Now after understanding What is Option Trading, let’s know the risk associated with it. External sweets are very unhealthy for our health likewise if you don’t understand the product and stock market movement well then trading directly in options makes it very riskier and that’s the reason many traders (95 per cent) lose money in the stock market because of lack of knowledge in the market. Do clear your basis first before you jump into such an advanced product like derivatives.
Understanding stock market volatility is another key point in options trading. 90 per cent of the time option trading gets very difficult to trade due to high or low volatility fluctuations in the market due to dynamic events which are taking place all the time. So, start reading news, events, economic cycles, results and more. Also Known as the Top-Down approach.
There are many strategies and risk management approaches to options trading including a well-known hedging strategy which also makes your trade beautiful and successful.
VI. How to Start Options Trading in India
I suggest you do paper trading before you directly jump into opening a trading account and putting your hard-earned money in options trading. Paper trading is much safer and makes you a confident trader, start practising paper trades i.e. write a trade that you want to take on a paper and track it with live market data with predefined Stop-loss, Target and Entry points.
Once you get confidence then start trading in a live market and for that, you need to open a trading account with any of the brokers and start trading. Opening a trading or demat account became very easy in India after digitalization so don’t worry you can open a trading account anytime within 24 hours. Focus on paper trade and get confidence levels boosted first before opening a real trading account. Use a Google sheet shown in below picture or table below for paper trading.
| Option Contract | Bank Nifty |
| Stock Price | 47000 |
| Strike Price | 47100 |
| Expiry Date | 13th December 2023 |
| Entry Price | Rs. 303 |
| Target Price | Rs. 580 |
| Stop Loss | Rs. 250 |
VII. Common Option Trading Strategies in the Indian Market
There are many strategies used in options trading like covered call, protective put, straddle and strangle strategies, bull call spread, bear put spread and many more.
We will cover these topics in upcoming posts.
You can use the Black and Scholes option pricing model developed by us – Options Calculator, which simulates the option price and gives to target price and stoploss points to take an option trade.
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Conclusion:
Options Trading is a much-advanced topic and you need to know many things in detail before you get a hands-on grip on it. We covered some of the aspects of options trading and we do so in upcoming posts.
We are trying to make it a better learning curve for your trading journey so don’t worry and start practising what we have already covered in this post and keep up to date with us for more information on Stock Market.
Visit the NSE India Site for Option Chain and Contract Specifications