Basics of Options
PROFESSIONAL OPTION TRADER (POT) TRAINING MODULE
Here, we will see how option segment is the best way for INTRA-DAY and POSITIONAL TRADER to trade successfully in stock markets.
A trader will be successful in trading only if he keeps on buying as well as selling the stock for short period in the ups and downs of market.But,in cash segment,trader can hold only buy position and can not hold sell position.For holding buy or sell both side position trader has to enter in future segment of market but future segment is extremely risky and may give heavy losses to trader if his trade goes in opposite direction.
Now,to avoid risk of future segment and also to make profit in short term ups and downs of stock market traders enter in options segment of market.
Now we will see option segment in brief.
In real estate a estate trader does business in following 3 ways :-
Let us say he has finalised to buy and sell a house of 1 cr then he has 3 options -
i)He will pay full 1 cr to house owner,he will buy the house and then he will sell it for profit.
ii)He will pay only the down payment ,he will take loan with interest for remaining amount,he will buy the house and then he will sell it for profit.
iii)He will pay only 1 lac and he will enter in a contract with house owner.Under that contract the real estate trader has to pay remaining 99 lacs in a months period to buy the house,if he does not pay the 99 lacs in 1 months period then his contract may expire and he will loose all his 1 lac paid to house owner and the house owner is free to sell the house to other party.
You can roughly assume that In stock market a stock market trader also does the trading almost same way. Off course,regulations and legal framework is completely different.
For example,If a trader wants to trade with shares of any company say Reliance worth rs. 1 cr then generally he follows 3 ways:-
i)CASH SEGMENT :-The trader pays complete amount and buys shares of 1 cr.
ii)FUTURE SEGMENT :-The trader enters into future contract where he pays only margin money and rest amount is loan on trader,which he has to settle by the month expiry.Either he will take delivery of shares or he will rollover the contract.
iii)OPTION SEGMENT :- The trader enters into OPTION contract where he pays only premium amount and he has to exercise his option by month expiry other wise his premium paid will become ZERO.
Kindly note this information is not complete but just a brief.
In this training, we are focused on option segment.
Let us check details..
Options contract is an agreement between a buyer and seller that gives the purchaser of the option the right to buy or sell a particular asset at a later date at an agreed upon price. Options contracts are often used in securities, commodities, and real estate transactions.
WHAT IS OPTION PREMIUM :-
An options premium is the cost for buying a call or put option. The two components that affect options pricing are the intrinsic value and time value.
CALL OPTION:-
an option to buy assets at an agreed price on or before a particular date.
The trader expects the price of stock to go UP when he buys call option.
The price of Call option starts rising when stock starts going up and above strike price.
PUT OPTION :-
an option to sell assets at an agreed price on or before a particular date.
The trader expects the price of stock to go DOWN when he buys put option.
The price of Put option starts rising when stock starts going down and below strike price.
STRIKE PRICE :-
The price at which a put or call option can be exercised.
EXPIRY DATE :-LAST THURSDAY OF EVERY MONTH.
i)ALL THOSE CALL OPTIONS WILL BECOME ZERO WHOSE STRIKE PRICE IS BELOW THE SPOT PRICE OF THE STOCK ON EXPIRY DATE.
ii)ALL THOSE PUT OPTIONS WILL BECOME ZERO WHOSE STRIKE PRICE IS ABOVE THE SPOT PRICE OF THE STOCK ON EXPIRY DATE.
The settlement price of call and put options will be the respective positive and negative difference between stock spot price and strike price on expiry date.
LOT SIZE :-Lot size of option contract is stipulated by stock exchange. For example lot size of Reliance is 500 shares. Buying 1 lot of option of Reliance means buying 500 units of that call or put option of Reliance.
RISK / REWARD OF CALL OPTION AND PUT OPTION BUYER :-
Maximum Loss: Limited to the premium paid for the option.
Maximum Gain: Unlimited as the market goes up or goes down.
EXAMPLE :-
The stock Reliance’s current market price is Rs.1000
A)CALL OPTION :- If Reliance goes UP to 1100 then CALL options of Reliance will GO UP.
B)PUT OPTION :- If Reliance goes DOWN to 900 then PUT options of Reliance will GO UP.
IT MEANS OPTION BUYER CAN MAKE PROFIT IF RELANCE STOCK GOES UP OR GOES DOWN.
PRACTICLE EXAMPLE :-
A)CALL OPTION :-
STOCK : RELIANCE
OPTION : CALL
STRIKE : 1000
DATE : 9/12/2015
RELIANCE STOCK PRICE : 917.75
CALL 1000 PRICE : 2.15
LOT SIZE : 500.
1 LOT PREMIUM VALUE: 1075 …(PRICE 2.15 * LOTSIZE 500)
DATE :17/12/2015
RELIANCE STOCK PRICE : 1009.70
CALL 1000 PRICE : 22.45
LOT SIZE : 500.
1 LOT PREMIUM VALUE : 11225 …(PRICE 22.45 * LOTSIZE 500)
CALL OPTION WENT UP BECAUSE PRICE OF STOCK WENT UP.
We can see that the option price went up from 2 to 22.Why option price became 10 times just in 9 days,because,This contract had underlying value of 500000 (Share price 1000 * Lot size 500).In option contract the profit and also loss in contract price is based on underlying price means share price.
Kindly note here,if the trend of share price goes in opposite direction then the option price will become ZERO equally fast.
B)PUT OPTION :-
STOCK : RELIANCE
OPTION : PUT
STRIKE : 1000
DATE : 01/12/2015
RELIANCE STOCK PRICE : 966.55
PUT 1000 PRICE : 40.70
LOT SIZE : 500.
1 LOT PREMIUM VALUE: 20350 …(PRICE 40.70 * LOTSIZE 500)
DATE : 09/12/2015
RELIANCE STOCK PRICE : 917.75
PUT 1000 PRICE : 80.80
LOT SIZE : 500.
1 LOT PREMIUM VALUE : 40400 …(PRICE 80.80 * LOTSIZE 500)
PUT OPTION WENT UP BECAUSE PRICE OF STOCK WENT DOWN.
But the most critical point is the option buyer must know the right trend, means he must know where the stock is going.. up or down. If he buys put and stock goes up or if he buys call and stock goes down then his option premium may become ZERO.
To understand trend of stock or of particular option the trader can take help of various technical analysis software available in market these days. Kindly note here that there is no such a software in the market which will predict the trend 100% accurate. Their accuracy can be from 30 % to 60-70%, hence never jump on trading after taking software. At least, 3 months paper trading is advisable before coming on any conclusion.
PLEASE NOTE HERE THAT THE INFORMATION IN THIS MODULE IS NOT COMPLETE BUT A BRIEF ONLY.TECHNICAL JARGON AVOIDED.LANGUAGE AND EXAMPLES ARE MADE SIMPLER SO THAT A BEGINNER UNDERSTANDS THE CONTENT.READ THE DISCLAIMER AND TERMS OF USE ON THIS SITE COMPLETELY.