Option Trading: It’s Not As Difficult As You Think

An option trading is something that the new investors usually don’t take up as it is considered to be a bit more complicated than traditional stock trading. However, if you master the art of option trading on the basis of your knowledge and awareness, then it surely has several advantages which the traditional stock trading lacks.

Before knowing in detail about different types of options, tips, and strategies, let us first understand what an option is.

An option is a derivative contract that derives its value from an underlying asset. In the option derivatives, the owner has the right to buy and sell securities at an agreed price and at a certain time period. In an option contract, the investor has the right but not an obligation to do so.

Just like a futures contract, an option contract to helps the investors avoid the risk. The only difference is that there is no obligation to buy as in the case of the futures contract.

Since the trading has now been digitalized to a great extent, no physical documents are required at the time entering an options contract. There are some important terms related to options trading that the investors need to be aware of before investing.

Terms Related to Option Trading:

Option: The investor makes the payment for the option, i.e., the right to make the desired transaction. However, there is no obligation to do so on the investor.

Derivative: As the word itself suggests, the derivative is something that derives its value from an underlying asset, which in turn determines the price of the option contract.

Agreed-upon price: Also known as the strike price, agreed-upon price, does not change over time. Even if the stock price varies, the agreed-upon price remains unaffected.

Certain time period: The time until the agreed-upon data is known as a certain time period. It is the period when the option expires. The strike price of the option can be exercised at any time until the expiration date.

Types of Options:

The types of options contracts can be classified into two broad and important categories, including a call option and a put option.

1. Call Option: The right to buy an option is known as a call option or simply call. It offers the investor a right to buy without the obligation to buy. For instance, if you have a call option of saying Reliance Industries then you have the right to buy Reliance Industries Option Contract but not an obligation to do so. In order to exercise the right in case of an option contract, the investor has to pay a premium amount. This amount of premium paid is referred to as sunk cost. There are index call options and stock call options. An index call option offers the right to buy an index. The profit or loss on the index call option is determined by the movements taking place in the index value

On the other hand, a stock call option is an option contract, based on an individual stock. Though the concept of index and stock call option seems to be different, the basic principle of trading in them remains the same. The investors buy the call option when they expect the price of the index or the stock to go up.

1. Put Option: Put Options are also simply called as put. It is an options contract where the buyer has the right to sell the underlying financial instrument at a specific price and at a specified future time. The sale price is fixed at a predetermined position in order to keep the investor insured against any downtrends in the price of the financial instrument. In case the price of the underlying security falls before the expiry date, then the buyer has the right to sell the security at a price called the strike price. This saves the investor from any further losses he might incur on selling the contract at a lower market price. However, the investor also has the right to not exercise the option if the price of the underlying security remains the same or goes up and earns a profit on the same.

Advantages of Option Trading:

Options trading offer a wide range of advantages which are as follows:

• Option buyers pay the premium to the option sellers, and hence there is no need to market margin calls for options trading.
• The cost of an options contract is lesser than the cost of futures contracts. The returns, too, are relatively higher, and the maximum loss that can be incurred by the buyer is also limited.
• Options contracts are much more flexible as the participants can indulge in price movements.
• Options are like price insurance.

About Author

Naresh Kumar Sharma

Naresh is an Expert Financial Advisory at Raghunandan Money. When it comes to studying markets, Naresh loves decoding stock prices, analyzing data, and understanding market trends. He has a deep knowledge and flair for both fundamental and technical analysis which makes him one of the most reliable experts in Raghunandan Money. Naresh is involved in training and writing informative blogs and articles on equity, commodity, traders, and investors.