Derivatives Trading Basics
by 5paisa Research Team Last Updated: 2022-06-15T21:31:26+05:30

Introduction

Options trading opens up tremendous opportunities for people acquainted with this investment instrument. If you are planning to try your hands in options trading, you have to understand call and put options, put call ratio, strike price, expiry date, ITM, OTM, ATM, and many more. Although options trading is never easy, proper knowledge can help you excel in the art of options trading.

What is Call Options?

Options are derivatives contracts dependent on an underlying asset like index, stock, commodity, or currency. Call options entitle you with the right (not obligation) to buy or sell the underlying asset at a specified price on or before the expiry date. If the underlying asset price exceeds the price you paid for the options contract, you will earn a profit. Conversely, if the underlying asset's price declines on or before the date of the expiry, you will lose the premium paid for buying the call.

Options trading is of two types - options buying and options selling. You can buy or sell call and put options. When you buy call options, you expect the underlying asset's price to increase on or before the date of expiry. In contrast, if you sell call options, you expect the underlying asset's price to decrease on or before the date of expiry.

Call Options Example - Buy Call Options

Let's assume you want to buy call options of the NIFTY index on 1st February. The spot price of NIFTY is 18000. You expect the index price to reach INR 18500 by 24th February. So, you buy 18500CE Out-Of-Money (OTM) call options at INR 200 x lot size. Now, if the NIFTY's spot price crosses INR 18500 on or before 24th February, your call options become In-The-Money (ITM), and you can expect the trade to be profitable. However, if the spot price of the index does not touch 18500, your call options remain OTM and you lose the entire premium you paid for the asset. But, if you want to withdraw the amount anytime before the expiry, you can do so at will. So, call options are best-suited when you are confident about the underlying asset price's appreciation.

Call Options Example - Sell Call Options

Consider the above example. You thought the spot price of NIFTY would cross INR 18500 and bought call options. But now you think the price of asset will remain below 18500 on the date of expiry. Hence, you sell call options of 18500 CE when the spot price of NIFTY is 18000. Since your call options' price is already ITM, the premium will be quite high. If the stock price drops further, you may expect a profit. But, if the stock price reaches or crosses 18500, you will bear substantial losses.

What is Put Call Ratio?

Put call ratio helps investors gauge the market sentiment. The put call ratio is determined after analysing the options trading volumes or the open interest. Generally, if the put call ratio is above one (1), the market is believed to favour the bears. In contrast, if the put call ratio is less than 1, the market is believed to favour the bulls.

The EndNote

Now that you know the key terms associated with call options trading, use this knowledge to sharpen your option trading strategies. 5paisa provides a low-brokerage trading account to test your understanding and take your trading skills to new heights.

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