What is option trading in indian stock market
What is an Option? Suppose you have bought an option of shares of ABC Company at a strike price of This option gives you a right to buy shares at INR before contract expiry.
The seller is under an obligation to sell shares to you at INR whenever asked for. The option seller is thus under an obligation to execute the contract. Terminologies used in options: It is the transaction price which is decided by the exchange. A pre-defined period when the option will expire.
This predefined period is last Thursday of every month for Indian stock markets. You can settle the contract even before this period.
Explained in case study Exercise day: It is the day when the option is exercised. It is the price of the stock underlying asset in the cash market. At the money ATMIn the money What is option trading in indian stock market and Out of the money OTM are the three terms which are used to describe the relationship between the options strike price and the price of the underlying asset stock.
This is a scenario when the options strike price is exactly the same as the price of the stock what is option trading in indian stock market the cash market. This is the break-even point i. This is a scenario when for a call option; the strike price is below the stock price and for a put option the strike price is above the stock price in the cash market.
This is a profit zone for our position if the option is exercised. This is a scenario when for a call option; the strike price is above the stock price and for a put option the strike price is below the stock price in the cash market. This is a loss making zone for our position if the option is exercised. They provide huge returns if the view proves right. It is recommended to always opt for a ITM option. In options trading, there are 3 contracts that are open at any point in time. Bullish Premium to be paid: INR 10 Strike Price: Total Investment made for one lot: Any price movement of the spot above would yield us profit.
If at all till the expiry the spot stays belowthen the option would make a loss and the maximum loss would always be equal to the total premium paid i.
If the spot rallies above what is option trading in indian stock market, say the premium goes up to say Since an option is a right given by the seller to the buyer, the buyer has the right to exercise that right. In the above case we sold the option and the profit was In the above case study 1, the CALL option seller would have received the premium of from the option buyer initially. This is the maximum money that he could make. If the spot rallies like it rallied above then the losses of the option seller are unlimited now.
If the option is exercised, the losses are tremendous. Bearish Premium to be paid: Any price movement of the spot below 90 would yield us profit. If at all till the expiry the spot stays above 90, then the option would make a loss and the maximum loss would always be equal to the total premium paid i.
If the spot breaks below 90, say 70 the premium goes up to say In the above case study 3 the PUT option seller would have received the premium of from the option buyer initially. If the spot falls below the break-even point as it did above, then the losses of the option seller are unlimited now.
Important points to note: Please do not be creative! As what is option trading in indian stock market stock price moves in the cash market, the option price also moves. Hence stop loss for options should always be followed in the cash segment only. If stop loss is triggered in cash segment, exit your option position also. If you see profits and can square-off your position, go ahead! But when it is falling, it falls very fast. There is going to be a bull market between today and Send your queries to: Understanding Options What is an Option?
This option gives the buyer the right to BUY. You generally buy a CALL option when you have a bullish view on the stock. This is same as going LONG in futures. This option gives the buyer the right to SELL. You generally what is option trading in indian stock market a PUT option when you have a bearish view on the stock.
All options that can be exercised Explained ahead on or before the contract expiry are called American options. All stock options in India are American. All options that can be exercise only on contract expiry are called European options. In India, options on the index i. In options trading, there are 3 contracts that are open at any point in time 1.
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As with any of the previous modules in Varsity, we will again make the same old assumption that you are new to options and therefore know nothing about options. For this reason we will start from scratch and slowly ramp up as we proceed. Let us start with running through some basic background information.
The options market makes up for a significant part of the derivative market, particularly in India. Internationally, the option market has been around for a while now, here is a quick background on the same —.
Clearly the international markets have evolved a great deal since the OTC days. However in India from the time of inception, the options market was facilitated by the exchanges. The badla system no longer exists, it has become obsolete.
Here is a quick recap of the history of the Indian derivative markets —. Though the options market has been around sincethe real liquidity in the Indian index options was seen only in ! I remember trading options around that time, the spreads were high and getting fills was a big deal. However inthe Ambani brothers formally split up and their respective companies were listed as separate entities, thereby unlocking the value to the shareholders. In my opinion this particular corporate event triggered vibrancy in the Indian markets, creating some serious liquidity.
However if you were to compare the liquidity in Indian stock options with the international markets, we still have a long way to catch up. There are two types of options — The Call option and the Put option. You can be a buyer or seller of these options. In fact the best way to understand the call option is to first deal with a tangible real world example, once we understand this example we will extrapolate the same to stock markets. Consider this situation; there are two good friends, Ajay and Venu.
Ajay is actively evaluating an opportunity to buy 1 acre of land that Venu owns. The land is valued at Rs. Ajay has been informed that in the next 6 months, a new highway project is likely to be sanctioned near the land that Venu owns.
If the highway indeed comes up, the valuation of the land is bound to increase and therefore Ajay would benefit from the investment he would make today. So what should Ajay do? Clearly this situation has put Ajay in a dilemma as he is uncertain whether to buy the land from Venu or not. While Ajay is muddled in this thought, Venu is quite clear about selling the land if Ajay is willing to buy. Ajay wants to play it safe, he thinks through the whole situation and finally proposes a special structured arrangement to Venu, which Ajay believes is a win-win for both of them, the details of the arrangement is as follows —.
So what do you think about this special agreement? Who do you think is smarter here — Is it Ajay for proposing such a tricky agreement or Venu for accepting such an agreement? Well, the answer to these questions is not easy to answer, unless you analyze the details of the agreement thoroughly.
I would suggest you read through the example carefully it also forms the basis to understand options — Ajay has plotted an extremely clever deal here! In fact this deal has many faces to it.
Now, after initiating this agreement both Ajay and Venu have to wait for the next 6 months to figure out what would actually happen. However irrespective of what happens to the highway, there are only three possible outcomes —. Remember as per the agreement, Ajay has the right to call off the deal at the end of 6 months.
Now, with the increase in the land price, do you think Ajay will call off the deal? This means Ajay now enjoys the right to buy a piece of land at Rs. Clearly Ajay is making a steal deal here.
Venu is obligated to sell him the land at a lesser value, simply because he had accepted Rs. Another way to look at this is — For an initial cash commitment of Rs. Venu even though very clearly knows that the value of the land is much higher in the open market, is forced to sell it at a much lower price to Ajay. The profit that Ajay makes Rs. It turns out that the highway project was just a rumor, and nothing really is expected to come out of the whole thing.
People are disappointed and hence there is a sudden rush to sell out the land. As a result, the price of the land goes down to Rs. So what do you think Ajay will do now? Clearly it does not make sense to buy the land, hence he would walk away from the deal.
Here is the math that explains why it does not make sense to buy the land —. Remember the sale price is fixed at Rs. Hence if Ajay has to buy the land he has to shell out Rs. Which means he is in effect paying Rs. Clearly this would not make sense to Ajay, since he has the right to call of the deal, he would simply walk away from it and would not buy the land. However do note, as per the agreement Ajay has to let go of Rs.
For whatever reasons after 6 months the price stays at Rs. What do you think Ajay will do? Well, he will obviously walk away from the deal and would not buy the land. Why you may ask, well here is the math —. Clearly it does not make sense to buy a piece of land at Rs. Do note, since Ajay has already committed 1lk, he could still buy the land, but ends up paying Rs 1lk extra in this process. For this reason Ajay will call off the deal and in the process let go of the agreement fee of Rs.
I hope you have understood this transaction clearly, and if you have then it is good news as through the example you already know how the call options work!
But let us not hurry to extrapolate this to the stock markets; we will spend some more time with the Ajay-Venu transaction. I would suggest you be absolutely thorough with this example. If not, please go through it again to understand the dynamics involved. Also, please remember this example, as we will revisit the same on a few occasions in the subsequent chapters.
Do note, I will deliberately skip the nitty-gritty of an option trade at this stage. The idea is to understand the bare bone structure of the call option contract. Assume a stock is trading at Rs. You are given a right today to buy the same one month later, at say Rs. Obviously you would, as this means to say that after 1 month even if the share is trading at 85, you can still get to buy it at Rs. In order to get this right you are required to pay a small amount today, say Rs.
If the share price moves above Rs. If the share price stays at or below Rs. All you lose is Rs. After you get into this agreement, there are only three possibilities that can occur. Case 1 — If the stock price goes up, then it would make sense in exercising your right and buy the stock at Rs. Case 2 — If the stock price goes down to say Rs. Case 3 — Likewise if the stock stays flat at Rs. This is simple right? If you have understood this, you have essentially understood the core logic of a call option.
What remains unexplained is the finer points, all of which we will learn soon. At this stage what you really need to understand is this — For reasons we have discussed so far whenever you expect the price of a stock or any asset for that matter to increase, it always makes sense to buy a call option!
Now that we are through with the various concepts, let us understand options and their associated terms. Hi Sir, Options is like greek and latin to me. Thanks for the analogies. No, all derivative contracts are routed via the exchanges. You cannot enter into an OTC arrangement, even if you do, it would not be regulated hence quite dangerous.
What benefit would Ajay get by calling off the deal before the expiry of 6 months? He will instead wait for the whole 6 months for any chance of the highway project. My first question Karthik is this: The dropdown value on the NSE website does not contain all months expiries — after 18th May we have 25th June followed by 24th Sept and then 31st Dec What happened to the other months?
For to only June and Dec contracts are available. What happened to the remaining? Saurabh, glad you noticed it! For all stocks options the expiry is very similar to futures. Hence we have current month, mid month, and far month contracts. However for Nifty there are several different expiry options.
Leaps are good if you have a super long term view on markets. However the problem with leaps in India is that they are not liquid, there are hardly any trading activity here.