Try your hand at Options Trading

The advantages of trading in Options outweighs trading in Cash markets, making it lucrative for investors and traders alike

The first question that anyone would ask is “why should I trade in Options instead of the Cash markets? The answer lies in the advantages the former offers. Some of the advantages have been listed below Leverage:
An investor can have a much larger exposure in the markets with the deployment of a relatively miniscule amount. For instance, if a person wants to buy 1,000 SBI shares at the current market rate of approximately Rs 1,800 in the cash segment, he would have to shell out a whooping Rs 18 lakh. That’s a huge sum of amount that would have to be deployed at one single time, not to mention the loss of interest on the capital and the huge loss if the stock prices fall.
As against this, he can buy 8 lots of SBI Call which has a lot size of 132 and gives him an exposure of 132 x 8 = 1,056 shares by paying a very small premium per lot. Thus, not only would he save on the capital deployed and on the interest, but also limit the loss on investment only to the total amount of premium paid. Hedging:
He can also use Put Options as a hedge against the downside to the stocks that he currently holds in his portfolio. Thus, he has an insurance against his stocks, wherein if the stock markets rise, the value of the stocks in his portfolio rises, but if the markets fall, the Put Options rise in value, protecting his investments against any significant capital erosion. Pure cash-based buying provides no such protection to cushion his fall during a market meltdown. Shorting:
Options give investors the advantage of shorting a stock or an index if at all he has a negative view on the stock or the index. He can do this by buying a Put Option of the stock or the index. Cash markets offer no such provisions to short a stock or index. Higher Profits:
There is a higher profit-potential in Options when the markets move in the direction favourable to a person’s trade in relation to the profits generated in the same uptrend in the cash segment. Diversity:
With trading options, an individual can not only trade stocks but also various Indices such as the Nifty, Bank Index, etc. This is of great importance when he has a view on the markets on the whole or a specific sector and not just a particular stock. The Cash segment offers no such unique benefit.
But wait, before rushing in to embark on the Options roller-coaster ride. It is imperative to learn to read the Options table  
 
  1st column indicates the underlying. In the example, the underlying is Nifty (index) and SBI (stock). 2nd column indicates whether it is a Call or a Put with ‘CE’ and ‘CA’ being Call Options and ‘PE’ and ‘PA‘being Put Options. 3rd column indicates the Strike Price, ice price at which the underlying asset can be bought in the future. 4th column indicates the month of expiry. (Note: In India the last Thursday of every month is the date of expiry). 5th, 6th, 7th and 8th columns indicate the Option Premiums with: day’s open price, day’s high, day’s low and day’s close respectively. 9th column indicates the Open Interest (OI). (Open Interest is the total number of outstanding contracts that are held by the market participants at the end of the day, usually indicated in thousands.) 10th column indicates the total number of contracts traded.
OPT-Nifty-27-Aug-2009-5000-CE at 30. This is how an Options contract typically appears on the trading screen. This is a Nifty Call option with a Strike Price of 5,000 and an expiry of 27th August, 2009 available at a premium of Rs 30.
_PAGEBREAK_ STYLES OF OPTIONS
On close observation, one can see that the Call Option for Nifty (an Index) is denoted by CE, whereas the Call Option for SBI (a Stock) is denoted by CA. Similarly, a Put Option for Nifty is denoted by PE and Put Option for SBI is denoted by PA. Thus, CE/PE are European Options whereas CA/PA are American Options. European Options cannot be exercised before expiry. In India, all Index Options are European Options. American Options can be exercised any time prior to the expiry. In India, all Stock Options are American Options. Note: There is a difference between Exercise and Square off of an Options contract. Squaring off is placing an opposite order to close out an existing position in a stock or an index option. For example, if an investor has bought a SBI 1800 CA Option at a premium of Rs 50, he can square it off by placing a sell order for the same quantity of SBI 1800 CA at a premium of say Rs 80. The profit in this case is the difference between the premiums, in this case, Rs 80 - Rs 50 = Rs 30, less brokerage and other taxes.
Whereas Exercise means exercising a person’s rights to buy a security if he has bought a Call or sell a security if he has bought a Put. It means taking or giving the delivery of the underlying asset (Index/stock). As a rule in India, all Options are cash settled, which means that one can only pay or receive the money due to him and not the actual underlying. OPTIONS CLASSIFICATIONS
ITM (In The Money): When the Option strike price is less than the market price of the underlying asset, the Option is said to be ‘in the money’ in case of a Call Option. When the Options strike price is greater than the market price of the underlying asset, the Option is said to be ‘in the money’ in case of a Put Option. ATM (At The Money): When the Options strike price is equal to the market price of the underlying asset, the Option is said to be ‘at the money’. OTM (Out Of The Money): When the Options strike price is greater than the market price of the underlying asset that can be a stock or an index, the option is said to be ‘out of the money’ in case of a Call Option and when the Options strike price is less than the market price of the underlying asset, the Option is said to be ‘out of the money’ in case of a Put Option. Factors Affecting The Options Premium Pricing
Price Of The Underlying: The price movement of the underlying asset affects the Options pricing in different ways. For a Call Option, as the underlying price increases, the Call Option premium increases and when the underlying price decreases, the Call Option premium decreases. Whereas for a Put Option, as the underlying price increases, the Put Option premium decreases and when the underlying price decreases, the Put Option premium increases. Time Decay Or The Time To Expiry: The longer the time left for the expiry of an Options contract, the higher will be the premium. This is because there is a greater probability of the Options becoming in the money with more time left for the underlying to move around.
As the time to expiry comes closer, the Options premium loses its value since the probability of the Options being in the money reduces. This erosion of the premium is called as time decay and is the biggest factor to consider while investing in Options. Volatility: Volatility is the probability of the underlying asset price moving up or down. The higher the volatility, the higher is the premium and vice versa. Volatility has a significant bearing on the Options pricing.
The other two factors which affect Options premium are risk-free interest rates and dividends. But they have a relatively negligible bearing on the Options pricinG. Source: Nirmal Bang