What is Options Trading?
In simple terms, options trading allows you to buy or sell the right to trade a stock, ETF, index, or even a commodity at a predetermined price by a set date. There are two main types of options: call options and put options. A call option gives you the right to buy, while a put option gives you the right to sell. You never have to exercise the option, but having the right to do so can open the door to big profits with limited capital investment.
Let’s dive into how you can trade in options, step-by-step.
How to Trade in Options: Step-by-Step Process
1. Set Up Your Trading Account
To start trading options, you’ll need a brokerage account that supports options trading. In India, major brokerage firms like Zerodha, Upstox, and ICICI Direct offer options trading features. However, you’ll need to fill out a questionnaire or go through a verification process to determine your experience level. Different brokers have options trading levels, which limit the type of strategies you can use as a beginner.
2. Learn Basic Terminology
Before placing your first trade, familiarize yourself with some key options trading terms:
- Premium: The price you pay for the option contract.
- Strike Price: The price at which the option can be exercised.
- Expiration Date: The date when the option contract expires.
- In-the-Money (ITM): When exercising the option would result in a profit.
- Out-of-the-Money (OTM): When exercising the option would not be profitable.
Bonus Point: Get Trading
3. Choose Your Trading Strategy
Once your account is set up, it’s time to choose a trading strategy. For beginners, the simplest strategies include buying call or put options. Let’s look at these strategies in detail:
3.1. Buying Call Options
A call option allows you to purchase a stock at a specified strike price before the expiration date. You cam use this strategy if you believe the stock’s price will rise.
Example:
You buy a call option on Stock XYZ at a strike price of ₹1,000, paying a premium of ₹50 per share. If the stock rises to ₹1,200, you can exercise the option, buy at ₹1,000, and sell at ₹1,200, netting a ₹150 profit per share (minus the premium).
When to Use:
You expect the stock price to rise substantially before the option’s expiration.
3.2. Buying Put Options
A put option gives you the right to sell a stock at a specific price. You’d use this strategy if you believe the stock price will fall.
Example:
You purchase a put option on Stock ABC with a strike price of ₹500, paying a ₹20 premium. If the stock price drops to ₹450, you can sell it at ₹500, earning a ₹30 profit per share (after premium deduction).
When to Use:
This strategy works well when you expect the stock price to decline before the expiration date.
4. Place Your Trade
Once you’ve chosen your strategy, you’re ready to place your trade. Most trading platforms make it easy to buy options:
- Log into your brokerage account.
- Choose the stock or asset you want to trade.
- Select “Buy” for a call or “Sell” for a put.
- Specify the strike price and expiration date.
- Enter the number of contracts you want to buy or sell (each contract usually represents 100 shares).
- Review the premium and transaction fees before confirming your order.
5. Monitor Your Trade
Once your trade is placed, you need to keep an eye on it. Options prices are influenced by multiple factors like time decay, volatility, and the movement of the underlying asset’s price. If the option reaches your desired profit level, you can either exercise it or close the position by selling the option before the expiration date.
6. Exit Your Trade
You can exit your options trade in one of three ways:
- Exercise the Option: If your option is profitable (in the money), you can exercise it before or at expiration.
- Sell the Option: If you don’t want to exercise the option, you can sell it for a profit or loss before expiration.
- Let It Expire: If the option is out-of-the-money and won’t be profitable, it will expire worthless. You’ll only lose the premium you paid.
Popular Options Trading Strategies
Beyond simple call and put buying, there are several other popular strategies:
1. Covered Call
A covered call is when you own the underlying asset and sell a call option. This strategy is typically used to generate additional income from stocks you already own but expect to trade within a range.
When to Use:
You own a stock and believe it will stay relatively flat in price over the near term.
Example:
You hold 100 shares of Tata Motors, trading at ₹500. You sell a call option with a strike price of ₹550. If Tata Motors stays below ₹550, the option expires, and you keep both the shares and the premium.
2. Protective Put (Married Put)
In a protective put, you buy a put option while holding the underlying stock. This acts as insurance for your shares, limiting potential losses if the stock price drops.
When to Use:
You own a stock but are concerned about potential short-term declines.
Example:
You own shares of HDFC Bank trading at ₹1,600. You buy a put option with a strike price of ₹1,500. If the stock falls to ₹1,450, the put option compensates for the drop in value.
3. Straddle
A straddle involves buying both a call and a put option with the same strike price and expiration date. This strategy profits from large price movements in either direction but is more expensive due to buying two options.
When to Use:
You expect significant volatility in the stock but are unsure whether the price will rise or fall.
Example:
You buy a call and a put option for Stock ABC with a strike price of ₹800. If the stock rises to ₹900 or falls to ₹700, you can profit from the price movement either way.
Risks Involved in Options Trading
Before jumping in, it’s essential to understand the risks of options trading:
- Time Decay: Options lose value as they approach expiration, particularly if the underlying stock price doesn’t move.
- High Leverage: While leverage can amplify gains, it can also magnify losses if the trade moves against you.
- Potential for Total Loss: If the option expires out-of-the-money, you lose the entire premium paid.
Frequently Asked Questions (FAQs)
1. How much money do I need to trade options?
You don’t need large amounts to start trading options. Many traders begin with ₹10,000 or less, since you’re only paying for the premium, not the full value of the stock.
2. Can I trade options on any stock?
No, not all stocks have listed options. In India, stocks on the NSE’s F&O list (Futures & Options) are available for options trading.
3. Are options trading safer than stock trading?
Options trading can be safer if used as a hedging tool (e.g., buying protective puts), but it also carries significant risks, particularly when selling options.
4. How do I learn more about options trading?
Start with free online resources, practice with virtual trading accounts, and gradually increase your exposure as you gain more confidence and experience.
Final Thoughts
Trading options can be a rewarding way to leverage capital, hedge against risks, and diversify your portfolio. Whether you’re bullish, bearish, or unsure about market direction, options give you the flexibility to profit in any market condition. However, they come with their own set of risks, so it’s important to start slow, keep learning, and practice sound risk management.
By following the step-by-step guide above, you’ll be ready to make your first options trade with more confidence. Happy trading!
