Profile TradersLearn Options Trading in India - Options Chain, Greeks, and Strategies | Profile Traders
Updated: Aug 29, 2021
When I started my trading career, I believed that only FIIs and big players could play option trading strategies. Besides, I had a tough time understanding options chain, put-call ratio, and option greeks.
Little did I know at the time how wrong I was!
Traders love to read and discuss options and many trading strategies using options. But most of them don’t find all the information in one source and face a hard time digesting all the information.
This article attempts to provide complete information about options and many trading strategies using options in a simplified manner.
Options Trading Tutorial (content)
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Popular Topics
What are Options?
An option is one of the trading instruments in the capital market.
Option in the stock market is a contract that permits (but is not mandatory) a trader to buy or sell an underlying stock or index at a predetermined price over a specific time.
A trader has to pay a small fee to buy these rights, and it is called the ‘premium’ of the option.
Call options Contract
A call option (CE) is a contract that gives the trader the right to buy the shares of a security at a specified price until it expires.
If a trader is buying CE, he expects the price of the security to go up so that he can make a profit either by purchasing the shares at a predetermined lesser level or by selling the CE contract.
Buying CE is similar to buying insurance. If nothing happens and if you don’t claim any insurance, the premium is of no use.
Similarly, if the price of underlying security doesn’t go up (due to either a down move or a sideways move), the premium of the CE becomes zero at the end of expiry.
Put options Contract
A put option (PE) is a contract that gives the trader the right to sell the shares of a security at a specified price until it expires.
If a trader is buying PE, he expects the price of the security to go down so that he can make a profit either by selling the shares at a predetermined higher level or by selling the PE contract.
If the price of underlying security doesn’t go down (due to either up move or sideways move), the PE premium becomes zero at the end of expiry.
Long vs. Short options
When a trader buys some shares of a stock anticipating the price will go up in the future, it is called the ‘Long’ position.
In contrast, when a trader sells some stock shares first (without having any position in the same stock), anticipating the price will fall in futures, it is called a ‘Short’ position.
But unlike stocks, if a trader buys CE (anticipating the price will go up) or PE (anticipating the price will go down), it is recognized as a ‘Long’ position in options (option buyer).
Suppose if a trader sells CE (anticipating the price will go down), or PE (anticipating the price will go up), it is recognized as a ‘Short’ position in options (option seller or option writer).
Options Trading Basics
Option Premium
The price that the buyer of the option gives to the option seller/writer.
Strike Price
The price at which the option buyer and option seller take the contract. It is also called ‘Exercised Price.’
For example, Banknifty is trading at 33265. A trader thinks it will go above 34200 in a week. Hence, he will buy 34200 CE, assuming he will make money. Here, 34200 is one strike price (call option example).
Similarly, security will have different strike prices to facilitate the trades between option buyers and option sellers.
Expiry Date
The last date specified in the option contract is called the expiry date. It is also called an exercise date.
After the expiry date, any options trader cannot exercise their options.
American Option
It is a type of option that can be exercised on any date before the expiry.
European Option
It is a type of option that can be exercised only on the expiry day. All the options instruments in India support only European options (hence the name CE and PE).
How to Trade Options?
We will take a simple options trading example to understand how to trade using options in NSE. Please note, the trading ideas below are chosen for the explanation’s sake and not to use in the trading.
The above image shows the daily chart of ICICI Bank.
The price is taking the support 550-560 levels. A few weeks back, it has shown a big breakout along with a gap from the same level.
Hence, a trader John, thinks the price will go up from here. He also predicts it can go up to 670 levels which is the all-time-high level.
The above image shows the ICICI Bank Option Chain snapshot for the 670 CE strike price (target level) for the immediate month expiry.
John decides to buy 670 CE by paying a premium of Rs. 2.85/- (highlighted in yellow).
The expiry is around 30 days away, and broadly speaking, there could be three possible scenarios:
Scenario 1 – The stock price goes above the strike price, say 700
Scenario 2 – The stock price stays below the strike price, say 620
Scenario 3 – The stock price stays at 670
The Intrinsic Value (IV) of the options at the expiry decides the profit/loss of the options trade.
IV = Spot Price – Strike Price
We need to include the premium paid (Rs. 2.85/-) in our calculation.
Profit/Loss in Scenario 1
700 (spot) – 670 (strike) = 30
Subtract the premium paid, 30-2.85 = 27.15
So the profit is Rs. 27.15
Profit/Loss in Scenario 2
620 (spot) – 670 (strike) = -50
But IV should be a non-negative number; hence we leave it to zero.
There is no need to exercise this option.
Hence, the loss is Rs. 2.85 (premium paid)
Profit/Loss in Scenario 3
670 (spot) – 670 (strike) = 0
Subtract the premium paid, 0-2.85 = -2.85
Hence, the loss is Rs. 2.85 (premium paid)
Two critical observations here:
When the ICICI Bank price stays below 670, the maximum loss seems to be just Rs. 2.85/-
The profit from this trade seems to increase exponentially when the price starts to trade above 672.85 (strike price + premium paid)
Hence, we can declare that John being an option buyer, has limited risk and unlimited profit potential.
ITM, ATM, and OTM in Options
What is In-The-Money (ITM) Option?
ITM option results in positive cash flow to the holder if it is exercised immediately.
For CE – when the spot price is higher than the strike price.
For PE – when the spot price is lower than the strike price.
What is At-The-Money (ATM) Option?
ATM option results in zero cash flow to the holder if it is exercised immediately.
For CE – when the spot price is equal to the strike price.
For PE – when the spot price is equal to the strike price.
What is Out-The-Money (OTM) Option?
OTM option results in negative cash flow to the holder if it is exercised immediately.
For CE – when the spot price is lower than the strike price.
For PE – when the spot price is higher than the strike price.
Options vs. Stocks
Stocks represent ownership in a company. In contrast, options don’t give ownership to the company.
However, options give the rights to buy or sell the stocks at a predetermined level until the contract’s expiry.
Investing in stocks is a safer mode of investment as compared to options. With options, a trader can make quick money, but the risk is also high with options.
Options vs. Futures
Both futures and options are derivative trading instruments. Both can be used for new investments or hedge the existing portfolio (speculation and hedging respectively).
The options contract gives the right (but not the obligation) to buy or sell a security at a specific time before the expiry. In contrast, a future contract demands buying and selling of a security.
Options Greeks
Option Greeks are the different parameters that affect the premium in real-time. It will help an option trader keep an eye on these parameters to reap the maximum benefits and avoid significant losses with options trading.
Delta
It measures the rate of change of options premium concerning change in the underlying price.
Gamma
It is the change in option delta per unit change in the stock price. In simple words, it measures the rate of change of Delta.
If the gamma is high, Delta is highly sensitive to option prices. Among OTM, ITM, and ATM options, ATM options will have the highest gamma.
Theta
It measures the impact on the option premium concerning the time remaining for expiry.
Vega
It is the rate of change in the premium concerning change in the volatility. If the option’s vega is high (either positive or negative), the option premium values are highly sensitive to any changes in the volatility.
Rho
It measures the rate of change concerning interest rate.
Options Chain NSE
Option chain consists of a listing of call and put options of an options instrument for various strike prices for the selected expiry period.
In this chain, strike prices are mentioned in the middle. On the left side, it will have the details for the call option, and on the right side, it will have the exact information for the put option.
NSE Option Chain gives the exact option chain details for all the eligible stocks and indices in India.
It also provides valuable information like Implied Volatility (IV), Open Interest, Change in OI, volume, Bid quantity, Ask quantity, NSE call put, etc.
Open Interest
It is nothing but the total number of open option contracts in the system. It indicates, these contracts have been traded but not yet liquidated.
Implied Volatility
It indicates the expected volatility of the stock during the options contract. Hence, by default, the options contracts with high IV levels will result in increased premiums.
Put-Call Ratio (PCR)
PCR is calculated by dividing the number of open interest in a put contract by the number of open interest in a call contract (for the same strike price and expiry date).
PCR = Put open interest/Call open interest
Many traders use PCR to gauge the mood of the market. A PCR ratio below 1 indicates that the people are buying more CE than PE. It suggests people are betting on a bullish trend in the next few days.
On the other side, if the PCR ratio is above 1, it indicates that the people are buying more PE than CE. Hence, traders are betting on a bearish trend for the next few days.
Options Calculator
An option calculator is based on the ‘Black-Scholes Option Pricing Model’ developed by Robert C. Metron and Myron Scholes in 1997.
It helps to calculate options greeks. It can also be used to calculate the theoretical price (fair price) of the options.
An options calculator receives many parameters such as spot price, interest rate, dividend, volatility, options price, and the number of days pending to expiry as inputs and gives various outputs as shown in the above image.
Visit the Option Calculator page if you want to arrive at any of these values.
Options Trading Strategies for Indian Market
Options trading is one of the most exciting gameplay in the trading community.
Many traders always ask questions like 'how to trade nifty options?' or 'how to trade bank nifty weekly options?' indicates the popularity of NSE call options/NSE put options in India.
Because of their potential to make quick money and some courtesy to Nifty/Banknifty weekly Expiry strategy on every Thursday.
Many trading strategies revolve around calls and puts. Long call, Long put, Short put, and Covered Call are some of the basic options trading strategies.
We will explore some of the advanced options strategies.
Option Spreads
Options spread is created when a trader buys and sells options of the same security but with different strike prices and/or expiry dates.
Traders use the option spreads in different ways. For example, the buyer of an option will use a spread to reduce the cost of his trade. Option sellers will use the spread to reduce the margin requirements and to put a cap on the loss.
There are three types of spreads:
Vertical Spread
Horizontal Spread (Calendar Spread)
Diagonal Spread
Vertical Spreads are built using the same security options, same expiry month but with different strike prices.
Horizontal Spread or Calendar Spread are constructed using the same security options, same strike price, but with different expiry dates.
Diagonal spreads are constructed using the options of the same security but different strike prices and expiry dates.