How to Trade in Options- For Beginners

"Hi Sir, I want to trade in stock and nifty options. Can you please guide on how to be make profits in options trading."

This is a frequent question we are getting in our inbox since a coupe of days. This post goes on explaining you about options trading.

Options Trading is the new trend in Indian stock markets these days, with turnover in options category being significantly higher than that of stocks, index or derivatives category. Just to take an example, on February 25, 2016, till 1:11 pm when we are writing this article the turnover for index futures at NSE is Rs 14,935.93 crore, turnover for stock futures is Rs 32,000.65 crore and turnover for index options is a whooping Rs 2,68,143.01 crore.

So options have become new choice for traders -- both retail and institutional traders -- in Indian stock markets. As our Finance Minister remarked earlier, Indian markets are primarily non-delivery based, meaning majority of trades do not result in deliveries and are settled in cash. Options in Indian market are cash settled as well with no delivery taking place at the option expiry date (which is always the last Thursday of every month).

In simple words, an option is a bet on direction of a stock or index. When a trader is taking a position in options, he is either buying or selling an options contract, and is making a bet that either the underlying stock or index will rise in price or fall in price before the monthly expiry date. Obviously, if the direction is predicted accurately, the trader stands to hold a profitable position, which s/he can close at or before the expiry date.

Options are basically of two types: call option and put option.

A buyer for a call option is taking a position that underlying the stock or index, would rise in value before expiry date. Means you buy call option when you are bullish

A buyer of put option is taking the opposite position that the underlying the stock or Nifty index, would fall in value before expiry date. You buy a put option when you are bearish.

However, there are few more things one must keep in mind, before he jump into options trading. One should be aware of the strike price and days remaining before expiry as well.

Options decay in value with time. The price options depends on a variable known as theta, also known as the rate of decay. Simply speaking, if you are a buyer of options, your options will lose a little bit of its value each day, even if the underlying instrument is not moving at all. This is due to time decay.

Because of this reason, professional traders or large institutions prefer options selling, rather than options buying, as they can benefit from this time decay if underlying instrument is not moving at all. However, option selling is akin to selling insurance and hence is detrimental to an individual retail trader as the potential liability can be significant if volatility increases overnight.

Another good way to get benefited from options is to take a combination trade in options.

If you are expecting the stock or index price to change dramatically in next few days you can buy an options straddle.

A long straddle involves buying of both a call option and a put option on the same stock or index at the same strike price and expiry date.

For example, if SBI is coming up with its quarterly results and we are not sure whether it will be a good result or not, we can buy a call option and put option at same strike price, preferably closer to current stock price. If results are good, call options would increase in price and would make up a profitable trade, else if results are less than expected put options would result in profits.

Another easy way to trade in options for a trader already holding a stock is to execute a covered call strategy.

This strategy has to be adopted in bearish markets like now, in case of stocks which are not expected to rise in price. If a trader is holding a stock in cash segment, he can sell the corresponding call options for the stock. When the stock declines in price as expected, the call options would be worthless and seller of call options would get to keep the option premium which s/he would have received while selling the call options. If the stock goes up, since the trader is already holding the stock in cash market, s/he would get compensated with the price rise of his holdings. This is a useful strategy for slightly bearish markets.

This is a simple introduction, however options trading is a complicated subject and one needs to do significant research before jumping into options trading. With the high options volumes witnessed in Indian markets these days, options trading is much more coveted than cash trading or futures trading and here to stay for long.

Also Read: 
Happy Trading
The Multiplier

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Write comments
February 28, 2016 at 8:49 AM delete

Sir when u are giving again the recommendations

March 6, 2016 at 7:06 PM delete

only when market settles................ regards

March 10, 2016 at 12:03 AM delete

Well written article my friend... Great job..