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Pros and Cons of Options Trading in 2020

Published : June 27, 2020

pros-and-cons of option Trading

The options market is a critical part of the derivative market, especially in India. Around 80 percent of derivative trading happens in the options market and the rest in futures. The options were available to trade on over the counter (OTC) since 1920 particularly on commodities. Equity options trading started in 1972 on the Chicago Board Options Exchange (CBOE). Currency and bond options started at the end of 1970 as over the counter trades. Philadelphia Stock Exchange started options on currencies in 1982. Interest rate options started to trade in 1985 on the Chicago Mercantile Exchange (CME). Options market was facilitated in India from the time of inception by exchanges. Options were available in the grey market as ‘Badla System’ which is obsolete now. The options market in India started in 2001 however, the volatility came later in 2006.

Type of Options trading:

There are American and European options available in the market. These have almost similar characteristics but the difference is also critical. One can exercise American style options at any time before the expiry while the European style options can only be exercised at expiry. However, In India European style options are followed for trading.

There are two types of options as the call option and the put option. One can buy or sell these calls and put options.

The call option is right to buy the particular underlying at a specified price and date however, there is no obligation to buy to call option buyer. The strike price is the price at which one has agreed to buy the underlying and the specified time is the expiry of the contract or time to maturity of the contract.

The put options are right to buy the particular underlying at a specified price and date however, there is no obligation to buy to put option buyer.

Advantages of Options Trading:

There are many advantages of trading options over the future and cash. There are several advantages are given below-

Cost Efficient:

Options come up with huge leveraging power. A trader or investor can get options position equal to a stock position at a much lower margin. For example, in order to purchase 200 shares of a stock at price 80, an investor requires paying Rs. 16000. However, if he was to purchase call options of equal weightage, the premium required would be around Rs 4000. So we can have a fair idea of options cost efficiency.

High Return Potential:

The returns on options trading would be much higher than buying shares on cash. As such, the option pays equal profit as the simple stock buying if had chosen the right strike. As we are getting options on lower margin and getting the same profitability the percentage return would be much higher comparatively.

Lower Risk:

Options are riskier than owning equities however; there are also times when options are used to avoid risk. Options are used widely to hedge the positions. The risk in options is predefined as the maximum loss can be the premium paid to buy the option.

More Strategy Available:

There are more strategies available in the options market to trade options. The trades can be combined to create a strategic position with the help of a call and put options of different expiries and strike prices.

Disadvantages of options:

As we have seen above that options can be highly rewarding however, there are some drawbacks of options trading. These are some key drawbacks of options explained below-

Less Liquidity:

Some stock options have lower liquidity which makes it very difficult for a trader to make entry and exit from the trade.

High Commissions:

Option trading is more expensive as compared to future or stock trading. However, there are some discount brokers that give the opportunity to traders to trade on lower commissions. But most of the full-service brokers charge higher fees for trading in options.

Time Decay:

Time decay is a worse thing while trading options. The value of your option premium decreases by some percentages each day irrespective of movement in the underlying.

Non Availability of All Stock Options:

All the stocks registered with exchanges do not have options contracts. This makes it difficult for a trader to hedge his position with options strategies.

Conclusion:

Options can be bought and sold each situation has its own advantages and drawbacks. Time is a key thing in trading the options as time decay runs against the buyer of the option. Trading cost is also a critical thing to consider while trading options. Options trading is more difficult to understand for a layman so you need to be careful while trading options.

About Author

Naresh Kumar Sharma
Naresh Kumar Sharma

Naresh is the head of Research at Raghunandan Money. When it comes to studying the markets, Naresh is someone loves decoding prices, data, trends & charts. Naresh carries an equal flair for both technical and fundamental analysis and that makes him truly one of the reliable experts in the market. Naresh writes informative articles & blogs for equity, commodity, traders and investors.

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