Although options trading is a bit more complex than stock trading, it helps make more significant profits when the security’s price rises and restricts losses when it goes down. Options in stock market are powerful as they can enhance a person’s portfolio through added income, leverage, and protection.
What is options trading?
Option trading allows traders to buy or sell stocks, ETFs, etc., at a specified price and within a specific date. It also gives the flexibility to wait to purchase the stocks at the decided price or date. Options trading allows investors to judge the future course of direction of the stock market or individual securities like bonds, stocks, etc.
When considering options trading, one should know what options are and their various types. If you are looking for tips and strategies for options trading for beginners, this article will help you find answers to each of your queries.
What are options?
Options are tradable contracts that give the bearer the right but not the obligation to buy or sell an asset at a predetermined price on or before the contract expires. Although options trading is a bit more complex than stock trading, it helps make more significant profits when the security’s price rises and restricts losses when it goes down. Options in stock market are powerful as they can enhance a person’s portfolio through added income, leverage, and protection. It can be used as –
- Leverage – When the security price rises, options trading helps you grab more enormous profits as you don’t have to put down the total price of the share. It lets you have control over the shares without buying them outright.
- Hedging – When the price of a share fluctuates, options trading protects the investor by allowing you to buy or sell the shares at a pre-determined price for a specified period.
Types of stock options trading
Options trading can be categorized into two types – call option and put option. Below is a detailed insight into the two categories.
- Call options – When the underlying security rises in price, it gives the opportunity to buy. Call option allows the trader to buy stocks at a pre-determined price within a specified period. The price paid is the strike price, and the last date of exercising the call option is known as the expiration date.
There are two ways to earn profit from the call option: Close your position (sell the call option) when the asset’s price surpasses the break-even price and make the difference between the paid and current premium. Or you can buy the asset at the agreed strike price.
- Put options – Unlike call options, where the trader has the opportunity to buy, the put option allows people to sell the underlying stock at the strike price on or before the date of expiry.
If you are willing to earn profits through put options, either close your position (sell the options contract) when the asset price is below the break-even level and make
the difference between the premium paid and the current premium. Or sell the underlying asset at the agreed strike price.
If the underlying asset’s price moves in the opposite direction to the desired call or put options, wait for the contract to expire, and your losses will equate to the amount you paid for the option.
Types of option trading strategies
There are multiple types of trading in the stock market. There are numerous options trading strategies, but if you are a beginner, you should initially be well-versed in these five for effective trading.
- Long calls (Buying calls) – A bullish trader should take this strategy. When the price of an asset is expected to rise, you can buy a call option using less capital than the asset. Also, if the price falls, the losses are limited to just the premium paid and no more.
- Long puts (Buying puts) – Bearish traders prefer this buying options strategy. It gives the holder the right to sell the particular stock at the strike price. Short selling is the only way a trader can benefit from this strategy.
- Covered calls – This strategy is preferred during a moderate or neutral market. Out of all other option trading strategies, covered calls are one of the safest options trading strategies. Here the investor sells a call option while also owning the underlying asset.
- Protective puts – It is a risk management strategy that guards against the downside movement of an asset. Although put options are a bearish strategy, protective puts are favored when the trader is still in a bullish trend but wishes to hedge against potential losses.
- Long straddles – It is one of the best stock options trading strategies in the Indian stock market. Here the trader purchases both a long call and a long put on the same underlying stock having the same expiration date and strike price.
Profitability in options trading
There are various types of trading in stock market, but every kind has some profitability scenarios, which make it worth opting for. Below is a list of the three significant situations that may lead to profitable trading outcomes.
- In-the-money option (ITM) – When the current index value is greater than the strike price, it is said to be an in-the-money option. It leads to a positive cash flow being exercised immediately.
- At-the-money option (ATM) – When the current index value is equal to the strike price, it is said to be an at-the-money option. It leads to no profit and loss, i.e., zero cash flow being exercised immediately.
- Out-of-the-money option (OTM) – When the index value is lower than the strike price, it is said to be an out-of-the-money option. It leads to a negative cash flow being exercised immediately.
