As you have landed here searching “What are Options in Trading”, I guess many people have so much confusion about Options. So I will try to make it simple for you with real-life examples.
There are so many people trading in the stock market. If you are trading or have been trading in the stock market you know that there are many segments in the stock market like Cash or Equity market, Future market, and Options market.
But although there are so many people out there who don’t know what are options in trading and hedging as well.
There is confusion among people that what are Options Buying and what is Option Selling? Who are Option Buyers and Option Writer? What is the difference between Buying & Writing? What is Put Holding and Put Writing?
Now I will try to explain to you in this article so that your concept of Call & Put, Holding & Writing.
It doesn’t matter which trading style you are trading like Option Chain, Divergence or any other but you should have a clear concept of Options. If you don’t have a clear concept then there is a very high probability that your trade may go in the wrong direction.
So let’s dive in
What are Options in Trading?
Options are Derivative. The price of derivatives is derived by an underlying asset for both stock or index.
Let’s assume you are dealing with a stock in the option like Yes Bank then their price will drive by that stock price. That’s why Options are called Derivatives.
What do Options Do?
Options give you right but there is not any obligation to buy or sell that contract on a particular price on a particular future date. The future date is called the expiry date and the price is called a strike price.
What is the Expiry Date?
The expiry date is the date on which your contract will terminate or expire. For the Indian stock market, this date is the last Thursday of the calendar month. This date may change if there is any holiday on that date. You must keep in mind the expiry date because the Premium is dependent on the expiry date.
What is the Strike Price?
The strike price is the price on which you can buy or sell that contract on the expiry date or before they expire.
When will We Get Profit?
See there are two things a). Call Option b). Put Option
If you are buying a Call or Put Option
In the case you buy a Call Option then you will get profit when the price of the stock or value of the Index goes above to the strike price on which you brought that contract. Because when you are buying a Call Option it means you are Bullish on that stock or Index.
In the case you buy a Put Option then you will get a profit when the price of the stock or value of the Index goes down on the strike value on which you sold that contract. Because when you buy a Put Option that means you are Bearish on that stock or Index.
If you are selling Call or Put Option
In the case of Selling Options which are also known as Writing you will get profit when the thing will go direct opposite from the above things.
What is the difference between Future and Option?
If you buy or sell the future then you have the right and also obligation to fulfill that contract.
And If you are Selling or Writing in the Options then also you have the right and obligation to fulfill that contract.
What is Call Holding?
Let’s understand this by an example. Assume you want to buy land. You have seen many places and finalize one of them. You also have seen that now there is less development around that place and you are sure that in some years this place will develop and when a place is developed than the prices o that land increases.
So you are Bullish about that land. If you buy that place I the Options terms it is called Call Buying.
If you are Bullish about any asset only then you should buy that asset.
Now you want to finalize that land but you don’t have much surety then what will you do?
You talk to the owner of that land and told him that I will buy this land after 2 Years in 2 Crore rupees. Will he/she agree? Only if you give him/ her token money. Let’s assume you have given them 5 lakh rupees as a token money/ advance.
And we all know that if you don’t buy that land after 2 years in 2 Crores that your advance will also go.
If we correlate this example to the Option Holding or Buying then that land is a stock 2 crore rupees is a strike price, your expiry is 2 years or before. You have to close that contract within 2 years. 5 lakh rupees is the premium amount that you are giving in advance.
Now there is 2 scenario
1). The area around that land develops
2). That area doesn’t develop
If the area develops it means your condition fulfilled. Let’s assume now the price of that land increases to 1.5 Crore. So you access your right and buy that land in 1 crore and sell it in 1.25 crore.
But you have given 5 lacks as premium over 1 crore then after adjusting premium your net profit is 20 lakhs.
But if that area doesn’t develop then will you buy that land?
If things not gone in the way as you expected then the price will also not follow as you expected. Let’s assume now the price of the land is 85 lakhs. Will you buy that land in 1 crore as you committed?
It is common sense that you will not give more money then what is its market value. And if you buy that land you will be in a loss of 15 lakhs.
Then you will not do anything, now your net loss is only 5 lakhs instead of 15 lakhs.
It is the same process that happens in the call option. If your strike price does not hit that contract loses.
What is Put Buying?
Let’s assume that you are the owner of that land then you also have two scenarios
1). That area around tat land develops
2). That area doesn’t develop
But you have a strong emotion that land will not develop as much. So you are afraid of losing money.
Now the value of that land is 75 lakhs. So you bought an insurance policy of 65 lakhs which ensures you that if the price of that land goes down to hat 65 lakhs then all the loss below 65 lakhs will bear that insurance company. So you gave 2 lakh rupees as a premium of your insurance.
If after some time land prices go down to 50 lakhs then you will bear 10 lakhs of loss from 75 lakhs to 65 lakhs. And the loss from 65 lakhs to 50 lakhs will bear by the insurance company.
So you have only a loss of 12 lakhs (10 lakhs+2lakhs) instead of 25 lakhs.
Now you have 4 possible scenarios
|Call Buy/ Call Hold||Bullish|
|Put Sell/ Put Write||Bullish|
|Call Sell/ Call Write||Bearish|
|Put Buy/ Put Hold||Bearish|
In the end, you will only get a profit if your strike price will hit.
Over to You
Well, I think I had added some value to your life.
Till next time… Goodbye 🙂
P.S. If you liked the post don’t forget to let me know in the comments. Also if you want me to cover something more on this topic let me know that too.
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