Updated: Dec 11, 2022
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)
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
The price that the buyer of the option gives to the option seller/writer.
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.
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.
It is a type of option that can be exercised on any date before the expiry.
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.