Home / Blog / BASICS OF OPTIONS TRADING

BASICS OF OPTIONS TRADING

stock trading Options trading fundamental

The common application of fund in market is investing in shares of companies. But return from shares takes time and is a long term investment. So how can we earn short term profits? The answer to this is trading in derivatives.

So what is DERIVATIVES? The values of derivatives depend on the value of stocks of the company. The most common derivative is the options. The value of options of a company depends on the current share value. We can also trade on the options based on Nifty or Sensex.

For the options dealt with Nifty, the overall value of share movement of all the shares listed in Nifty will affect the price of the options. For options, there is the RIGHT to buy/sell contracts on/before expiry date.

Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Each option contract will have a specific expiration date by which the holder can exercise their option. The stated price on an option is known as the strike price.

There are 2 types of options: Call Option & Put Option. Call option & Put option are opposite to each other and to making use of the volatility while trading in call &put option is called Option Trading.

So the basic question is: Why Option Trading? The answer to this is:

  • Option trading gives the traders a huge profit with the minimum capital invested.
  • The profit margin if traded with the trend, can give us 5 times the capital.
  • All this capital can be earned in a very short span of time.
  • Option trading is a short term investment. Thus the span of generating profit is very less when compared to investment in Equity.

The types of Market should be understood by the trader to operate better. The types of market are as follows:

  • Bearish - The market is expected to go low. Buying Put option is advantageous.
  • Bullish - The market is expected to go high. Buying Call option is advantageous.
  • Side way - The market is expected to go on either of the direction drastically (OR) is in same range of points for a time period. Thus here, hedging is preferable.

The hedging here refers to buying or selling a call option and a put option simultaneously (ie) taking up opposite position to safeguard the position we already hold.

So what not to do to avoid common risks? That's the mindset of the people.

  • When the option chosen is against the trend, close the option even if it is in loss.
  • Many traders have lost money in the market because they wait for their loss to turn profit (OR) no profit no loss scenario.
  • If the option already taken is against the trend, traders wait/ expect the market to reverse itself for the benefit of the traders.
  • Before entering or exiting the market, know the market, analyze and then start trading.

What is averaging the options?

Averaging the options mean that the options are traded in the same direction even if the market trend is slightly against us.

For example

When the nifty spot is 14400, and the market trend is uptrend, we buy a 14350CE @Rs.190. When in uptrend, there is small fall in the market. This means that there is a opportunity to buy another lot in the call.

Here we buy another call and average it with the previously bought call.

Thus when the market again turns up, the profit is higher.