Options trading has emerged as a classy and remunerative alternative to the cash segment in the stock market. Be it options buying or selling, there are endless possibilities for investors and traders to make handsome gains through option trading strategies. The following sections underline the process and meaning of options trading and explain call and put options in detail.
What is Options Trading?
An option is a financial contract that provides an investor or trader with the right to buy or sell a stock, ETF, commodity, currency, or benchmark at a specified price for a specified period. Options contracts come with a fixed expiry date, usually the last Thursday of a calendar month. When the specified date of expiry arrives, the contract expires, and its value becomes zero. Unlike futures, options do not obligate the buyer or seller to honour the contract.
Options trading in the stock market means you do not own the shares until you exercise the option. This feature makes options trading different from stock trading. When you invest in a stock, you become part-owner of the company. However, when you trade options, you simply express your desire to own the company's shares on a specified date and not own them for real.
Call and Put Options - Meaning and Significance
Investors buy a call option when they are certain that the price of the underlying asset will increase to the level they anticipate before the contract expiry date. For example, if you think that the price of XYZ stock will reach INR 100 from INR 80 within a month, you can buy an options contract at the strike price of 100. If the stock price reaches INR 100 before the specified date, you make a profit. But, if the stock price does not reach the intended level, you lose the money paid to buy the options contract.
Investors buy a put option when they feel the price of the underlying asset will decline to the level they anticipate before the contract expiry date. A put option lets buyers hedge their position against trades in the cash market.
Options Trading - The Benefits
Here are the top benefits of options trading in the share market:
1. Less Risky than Futures
The most significant benefit of options trading is that it doesn't make you an owner of the stock - you only invest in a part of the underlying asset. You can also come out of the contract any time you want.
2. Loss is Limited
In options trading, your loss is limited to the premium you pay, in case the spot price is far away from the strike price on the date of expiry. However, option selling is a little more complicated than options buying, and both profits and losses might be more pronounced.
3. Less Upfront Costs
Options trading is leveraged, meaning you have to pay a fraction of the original cost of purchasing shares. For example, if the lot size of XYZ stock is 100 and the stock price is INR 100, you have to pay INR 10,000 for purchasing the shares. But, if you take the options route, you may buy the same quantity of shares by paying a marginal amount of around INR 2,000.
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