Option Trading
Options trading is a method of investing in financial markets that utilizes contracts called options, which grant rights but not obligations.
Core Concepts
- Option Contract: A financial agreement tied to an underlying asset (like a stock, index, or commodity).
- Call Option: Gives the buyer the right to buy the asset at a fixed price (strike price) before or on a set date.
- Put Option: Gives the buyer the right to sell the asset at the strike price on or before a specified date.
- Premium: The price paid to purchase the option.
- Expiration Date: The deadline by which the option must be exercised.
How It Works
- Buying Calls: If you expect the asset’s price to rise, you buy a call. Profit arrives if the market price goes above the strike price plus the premium.
- Buying Puts: If you expect the asset’s price to fall, you buy a put. Profit comes if the market price goes below the strike price minus the premium.
- Selling Options: You can also write (sell) options, collecting the premium but taking on the obligation if the buyer exercises.
- Leverage: Options allow control of large positions with relatively small capital, magnifying both gains and losses.
- Strategies: Investors use options for speculation, hedging (protecting against losses), or generating income (e.g., covered calls).
Example:
- Stock XYZ trades at ₹100.
- You buy a call option with a strike price of ₹105, a premium of ₹5, expiring in one month.
- If XYZ rises to ₹120, you can buy at ₹105 and immediately sell at ₹120, making ₹15 profit minus the ₹5 premium = ₹10 net gain.
- If XYZ stays below ₹105, the option expires worthless, and you lose only the ₹5 premium.
Key Risks
- Options can expire worthless, meaning you lose the premium.
- Selling options can expose you to unlimited losses.
- Market volatility and timing are critical.