Option trading involves buying and selling options contracts, which give the right but not the obligation to buy or sell an underlying asset at a pre-agreed price (strike price) before or on a specified date (expiry date).
The buyer pays a premium to the seller for this right.
Options are derivatives, meaning their value is derived from the price of an underlying asset (stock, index, ETF, etc.).
How Does Options Trading Work?
Buyers gain the right to exercise the option anytime before the expiration (American style) or on the expiration date (European style).
Exercising is optional; if conditions aren’t favorable, the buyer can let the option expire, losing only the premium.
Sellers (writers) are obligated to fulfill the contract if the buyer chooses to exercise.
Types of Options
Type
Meaning
Call Option
Right to buy the asset at a set price before expiry (if profitable).
Put Option
Right to sell the asset at a set price before expiry (if profitable).
Key Terms in Options Trading
Term
Definition
Premium
The cost paid by the buyer to the seller for the option contract.
Strike Price
The price at which the option can be exercised.
Expiry Date
The final date by which the option must be exercised.
American Option
Can be exercised anytime up to the expiry date.
European Option
Can be exercised only on the expiry date.
Index Options
Options where the underlying asset is an index (e.g., Nifty, Bank Nifty).
Stock Options
Options where the underlying is a stock.
Participants in Options Trading
Participant
Role
Buyer
Pays the premium and has the right to exercise the option.
Seller (Writer)
Collects the premium and is obligated to fulfill the contract if exercised by the buyer.
Popular Options Trading Strategies
Long Call — Buy call option (bet on price rise).
Short Call — Sell call option (bet on price fall or stagnation).
Long Put — Buy put option (bet on price drop).
Short Put — Sell put option (bet on price staying above strike).
Long Straddle — Buy both call and put at the same strike (bet on high volatility).
Short Straddle — Sell both call and put at the same strike (bet on low volatility).
Profitability Scenarios in Options
Scenario
Description
In-The-Money (ITM)
Exercising the option yields profit. • For a call: Spot price > Strike price. • For a put: Spot price < Strike price.
At-The-Money (ATM)
No profit or loss if exercised. • Spot price = Strike price.
Out-of-The-Money (OTM)
Exercising the option results in a loss. • For a call: Spot price < Strike price. • For a put: Spot price > Strike price.
Option trading is flexible, with limited risk for buyers (limited to premium paid) and obligations for sellers. Success in options trading requires understanding of market movement, pricing, and risk management.
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