Learn Options Trading – Basics for Beginners

Learn-Options-Trading-Basics-for-Beginners-

Click below for playing the video

YouTube player

 

Transcript:

Thanks for joining and good evening to all of you.

 

So the last time when I was doing the livestream on options trading we did a spread strategy – debit spreads.

But I felt that maybe there is also a need to understand the basics. So that’s why, this session is for those who are just beginning or wanting to learn the very basics of option trading.

 

These are the very fundamental basics of options trading, which is good for beginners. Of course, those who have been doing options trading for a while, they would already know all this but for those who are very new or are planning to start doing options, then this is a good session to be in.

 

Okay options are different from stocks in terms of their behavior and so we can’t apply the same logic that we are using for stocks to options trading and that is why it is important to understand what options are. So let’s start off.

 

The standard disclaimer first – I’m not a SEBI-registered analyst so none of the discussions here constitute trading or investing recommendations. This is purely educational.

 

DISCUSSION TOPICS FOR TODAY

Okay so we’ll be discussing basically three things today. This is not an exhaustive session but we will just discuss what options are in the first place. Call and Put options specifically and the second point is something called “money-ness of options” – so based on where the spot price is right now and which strike price of the options we are selecting, there is something called moneyness so – atm itm and otm is nothing but at the money, in the money and out of the money. So we’ll discuss that and how it affects the price and the third thing that we will discuss is components of price – intrinsic and time value. So the option price consists of two major components – intrinsic value and time value. So we will look at that. It would be good if you are asking questions, so i can address those along the way which will make the session much more beneficial.

 

DIFFERENCE OF FUTURES AND OPTIONS

What is the difference between options and futures? Right so futures is a forward contract so to say and there is a specific lot size for that. Futures and options both are derivative instruments that’s the similarity both are derivative instruments in the sense that  both the instruments that have some underlying asset on which it is based. So let’s say if it is an index option or an index future the underlying asset is the index. So nifty is one index, bank nifty is another index, so based on the index there are futures or forward contracts and also another type of a derivative instrument is the option. When a person is buying a future or selling a future they are essentially entering into a forward contract which will be honored on a future date but when you are buying a call option or a put option you are just buying the right to buy or sell. It does not involve the obligation, right that is the main difference. So what you are doing is that you are buying the right to buy or right to sell at a particular price, within a specified date, you pay a premium for buying that right and that is the option price. The futures is a forward contract which is an obligation but the option does not have the obligation. It means that the buyer has the option to exercise the right or not exercise the right. So that I believe is the theoretical difference between options and futures of course there are a lot of other differences in terms of cost and turnover and all of those things.

 

BASICS OF CALL OPTION

So let’s see the call option. There are basically two types of option as we discussed call option and put option. First we’ll go through the call option. Call option is a contract and as we just said it gives the right but not the obligation to buy at a set price. So there is an option for the buyer. He may exercise the right or he may not exercise the right. Let’s say the underlying asset is nifty, I’ll just use the example of nifty for easy understanding. I’ll just use this site opstra, okay this is nifty spot price is 17153 and you look down to the option chain. There is this option chain like this you will see this closest strike to 17153 is 17200 and that is marked in yellow which is the spot price, which is what we say at the money. It is at the money and anything that is below 17200, if it is a call option, is in the money and anything that is above 17200 is out of the money.

Now my view is the market is going to go up. I’m being bullish about the market. So what do I do? I want to get a call option. It gives me the right to buy at a specified underlying asset at a set price on or before a specified date.

Now 17200 is the spot price of the market. Let’s say I am buying the right to buy the market at 17100 that is, the strike price 17100. So I want to buy this call okay and the present premium is 224 rupees so if I want this right the right to buy at 17100 when the market is at 17200 essentially getting 100 rupees discount right this is the right that I’m buying and because it is at 100 rupees discount that is the strike price is lower than the current market price so if I buy at the market I will be getting at 17200. But I am actually purchasing a right to buy at 17100 for which I am paying a premium of 224 right what am I expecting now of course this is if you look at it right here at in this moment it is not a profitable trade why because  I’m paying 100 rupees extra in the market to buy at 17 200 and I’m getting a discount of 100 rupees at this strike price but to get the discount of 100 rupees I am paying 224 premium right so in in effect I’m paying 124 rupees extra so that is it’s not a profitable trade when you look at it right now so then why would I be interested in buying a call option. If my view is bullish that is the market is going to go beyond 200 points beyond the premium that I’m paying okay so market is at 17 200 which is already 100 points away and the market will move a minimum of 125 points further upside that’s my view and if it moves then my trade is going to be profitable because I bought this option at 224 and the price of this option will go up if the market goes up okay.

So let’s add this position and see how the payoff graph looks. So this is the payoff graph if I am buying a call option what is the maximum loss that I will bear in this trade 11 212 which is 224 multiplied by the lot size that is 50 in case of nifty index so that’s the max loss that I will be bearing on this on this trade and if you see the breakeven is at 17 325 which is actually the strike price plus the premium paid. The market is here right now and I want it to move and when it moves beyond 17 325 I will actually  end up making a profit on this option so I may not  wait till the  till the expiry 31st march 2022. So there is a specified underlying asset and there is a specified date this is important okay so the option that I’m buying here is set to expire on 31st march 2022. So whatever I’m expecting the market to do it has to do before this date. If it if it doesn’t behave as I expected to behave before this particular date then this option will end up being worthless because 31st march 2022 is the expiry date of that coupon so to say you know it is a coupon that is valid till 31st march to 2022 and after that it will be it will be worthless.

 

WHAT IS MORE PROFITABLE – OPTIONS OR EQUITY?

So what is more profitable options or equity trading?   Options are more profitable in the sense that look at this the lot size is of 50. For purchasing that position 50 units if you let’s say I mean this is the index right so we are not purchasing index is not available in the cash market but suppose this is a stock okay let’s take the example of a stock let’s take reliance.

 

You get leverage you, get you can pay a lower margin but if I buy the same thing in options okay how do I buy that I earn it so let’s say I will buy an at the money call I am expecting that’s my view and if I buy an at the money call  2600 call okay so I get it at 31 rupees so my outlay would be 31 multiplied by 250 which is the lot size which is 7762 rupees only right so whatever profit I get  it is on this amount the amount of investment is lower and therefore the return on investment is very high so if you are asking what is profitable whether options are equity trading the benefit with options is you get leverage your capital that is deployed in this case is much lower than that you would actually require in the cash to buy the similar lot size okay 250. Of course in cash market you can buy even one share so that’ll be just 2600 but then again the profit that you get on that when you if you calculate in percentage terms higher so that is the advantage with options but of course it also carries a huge amount of risk.

 

I would suggest that you start with cash market okay don’t get into options right away but you can start learning about options even if you’re not putting money you start learning about options start paper trading options but if you are taking the very first step in the market this is   this is too risky so it is better to start in the cash market and then slowly progress towards option trading. Options are more volatile because you get like I said here the return on investment is very high and the amount of profit that you get on the investment and the return on investment is very high so and now this works both ways okay it’s a two-edged sword if your view goes wrong and then it will move much faster than  the stock so if you calculate the loss on the deployed capital again the loss percentage will also be much higher than what you actually incur in the cash market and the second point is in the cash market even if you are facing a loss you still have the stock in your demat account right you until the time that you sell it it’s still there and you can hold it for  years together but you can’t hold an option four years together  so if this is 31st march expiry if that is the option that you have bought you can hold it till that. You cannot hold it more than that right and till this so that’s the maximum you can go.

 

So my advice to you would be  definitely what you’re saying is right long term investments are safer but if you want to try something more try swing trading not intraday. You may have all the knowledge in the world but when you see the profit and loss emotions and that is where we actually lack and that is where maturity needs to come in play so what I suggest is don’t do intraday but do swing trading I had a session before this which dealt with the swing trading and that’s a very good   strategy to employ for those who are new to the market and even for those who have spent time in the market. Swing trading is a very good strategy you can get much more than 10 percent in swing trading if you do it well.

Swing trade is a trade where you can you hold the trade for a few days to a few months okay so you can try that okay thank you

 

BASICS OF PUT OPTION

Okay so we were discussing about the put option if you have missed anything in between you want me to explain it again please do let me know I’ll do that.

So my view is that the market is going to go down so I buy a put option at strike price 17 200. Why am I taking 17 200 the spot price is 17 153 okay that’s if I sell at in the in the spot market I am getting 17 153 but I am buying a right to sell at 17 200 which is higher than the current market price and for that I’m paying a premium of 184. So like we said earlier it is still a lot loss-making trade because I’m paying 184 to get a profit of less than 184 but my view is that the market is going to go down and if it does go down then this 184 is going to increase okay and that is where my profit is coming from if it does not  move according to my expectations then the price will decrease and I’ll have to book a loss so the basically it are like somebody was saying it is profitable in options or cash basically it is these are highly leveraged  instruments so you get a huge amount of return in a short span of time on a very low deployment of capital so that’s the advantage of it and that is also the  risk.

That is there because you if for a small amount of capital you can also lose a lot of money in terms of percentage returns so that is the advantage of it and that that is also the disadvantage okay.

 

MONEY-NESS OF OPTIONS – IN THE MONEY, AT THE MONEY AND OUT OF THE MONEY OPTIONS

The second point is money-ness of the options which is at the money, in the money and out of the money so the like we said earlier if 17 200 is the spot price okay so all of these the left side is the call option here and the right side of the strike price is put options here so 17 200 and let’s say I want to I buy a 17 000 call option okay so spot market is higher  the spot market price is higher than the strike price so this is  as a call option it is called in the money in the money because I am buying a right to buy at 17 000 when in fact the market is at 17 200. Okay for the same reason in the very opposite way if I am buying 17 400 then I can buy it at a lower price in the current market 17 200. But I am buying a call at 17 400, the right to buy at 17 400 so that’s why it is called out of the money option. The same strike price as the spot is called at the money option so if it is a call option the lower strikes are the in the money option, the upper strikes, the higher strikes are out of the money option and the same strike as the current market price is the at the money option and of course as you would understand that this is changing okay this is not a static thing it is it keeps on changing with the change in the current market price.

Now the very opposite will happen in the put option why because let’s say if I’m buying a 17 400 put while the current market price is 17 200 what am I doing. I am getting the right to sell at 17 400 while the price is at 17 200 right so there’s a 200 rupees profit over there I’m getting the right to sell at 17 400 while the market is at 17 200. So it is the in the money put so input the reverse is true the higher strike prices are in the money and the strike price at the at the spot prices is at the money and  the lower strike prices are out of the money. Why? If i buy 16 800 put what am I doing? I’m buying the right to sell at 16800 where in fact i can sell it in the open market at 17 200. Right why should I take this loss so it is it is called out of the money so that is money-ness of the option.

Now why is it important to know the money-ness of the option? Because it has an impact on the price. As of now we are not going to go into that detail what is the impact of the price and all of those things but I’ll just give you a small suggestion that if you’re doing options try to be at the money or slightly in the money maybe 100 strikes you know in case of nifty 100 points in the money. Don’t deal with out of the money, extreme out of the money or extreme in the money options because that’s where the most danger lies.  Why is it so  we will try to explore that in another session but for the moment if just a suggestion that try to stay at the money or slightly in the money okay that’s where you’ll be able to get your profits without taking too much of risk.

 

PRICE COMPONENTS OF OPTIONS – INTRINSIC AND TIME VALUE

Now the option price components okay there are two components – intrinsic value and time value so intrinsic value plus time value is equal to the price of the option. So let’s say 16800 okay 16 800 put is 58.35.

 

Now in this 58.35 what is the intrinsic value and what is the time value? I’ll explain that 16800 put is the right to sell at 16800 while the market is at 17200 so it is a 400 points in loss in out of the money.  Okay so there is in fact no intrinsic value in this. The entire 58.35 is only time value and the time value will keep on decreasing as time passes and the closer it gets to the expiry the closer it gets to 31st march in this case, this 58 will go to zero if it all other things remaining the same. if the market is at 17 200 as it is right now even if it is at 16 800 and 16801 it is still out of the money and it will still go to  zero so in this case the out of the money options there is no intrinsic value in the  in the price of the option. The entire value is a time value. I hope you understand this let me let me take an in the money option okay 17200 is the current market price I am buying the right to sell at 17 400 so 17 400 put what is the what is the cost 299.85 almost 300 rupees okay so 17 400 minus 17 200 so there is a 200 point gap here in the money and that 200 is the intrinsic value the rest of the 99.85 is the time value.

So let’s say all things remaining the same if the market stays at 17 200 as on 31st march the price of this option will be 200 rupees the entire time value will go to zero. 99.85 will go to zero only the intrinsic value will remain okay why because i have a right to sell at 17 400 while the market is at 17 200 so there is a 200 rupee straight profit over there and the 200 rupees intrinsic value will remain as on date of expiry the time value 99.85 will be reduced to zero as in the date of expiry and the closer you go to expiry this 99.85 will keep coming down.

 

Let’s also take an example of the call option just to help you understand

Let’s say I buy a 17 000 call option

Again the price is at 290 rupees right what is the spot 17 200 at the money is 17 200 and the strike price that I have chosen is 17 000. So I have a right to buy at 17 000 rupees while the current market price is 17 200 so I have a 200 rupees trade profit over there that is the right I have to buy at 17 000 when the market is at 17 200. So out of this 290 200 rupees is the intrinsic value that is the difference between the strike prices in case of the in the money option and 90 rupees is the time value which will be reduced to zero  all other things remaining the same again if you take the out of the money option 17 to 100 call or 17 300 call 123 rupees 124

Rupees okay so it is 17 300 call while the market is at 17 200. I’m buying a right to buy at 17 300 and the market is at 17 200 so there is a 100 point loss over here why should I buy it 17 300 when it is available in the open market at 17 200 right unless I expect the market to go beyond 17 300. So all of these 125 rupees is there is no intrinsic value in this as of now there is no intrinsic value all of this 123.95 rupees is time value and if it is time value it is going to get reduced to zero all other things remaining the same. The time value will go to zero and this is something that every option trader should know the intrinsic value and the time value what will be the price of this option going forward as it comes close to expiring what will be the price of the option this is something that I need to know and as an option buyer this is something that will determine whether you’re profitable or not.

 

MARGINS REQUIRED FOR BUYING AND SELLING OPTIONS

okay how much money required for option buy and sell if they buy then again closing will be required additional funds or not and what is the difference between why sell higher margin is required,

 

So in this case in fact there is if you’re buying an option in fact there is no margin okay whatever you are paying is the full cost so in case you are buying 17 300 option it is 124 rupees here in this case the nifty lot size is 50 so 124 multiplied by 50 will be the full price okay yeah you are expected to pay the full price there is no margin now in case of the option selling because the risk is higher the risk in the buying is the is limited to the cost that you pay and because if you are selling an option  you are actually  giving the other person the right while you are undertaking an obligation what we saw here is buying the right not the obligation the seller of the seller of the option is giving the right which means he’s taking on an obligation so if a seller of the call is giving the right to the buyer to buy at a particular price then he is taking on the obligation to deliver that amount of stock or whatever is a lot size that amount of stocks at that price that’s an obligation that’s not that’s not the right okay so if the buyer exercises the option the seller has to fulfill the obligation that they required that is why higher margin is required there is more risk in case of  selling the options right and that’s why it is  okay and what’s the next question if you buy then again at closing will be required additional funds or not in case of selling yes because if margin Requirements will change according to the market and if it is coming closer to expiry again margin requirements will increase so if you are selling options your margins will change but if you’re buying then you have already paid the full cost so it’s not going to change right okay

 

Thank you this is a very basic session   so if you’re a beginner I hope this is helpful and  if you have questions then I’ll take it also if you have some questions which is not addressed in this presentation which will also help me to   take another session on the option basis because this is definitely not an exhaustive   presentation there’s a lot more in this right now we have just touched the   surface of it so there’s a lot more option Greeks are there and how option behaves according to the Greeks in the money out of the money when is it good to buy not to buy all of those things so there are a lot of more things that are there in this but  if you’re interested we can have sessions on that so

 

I just explained with the call option and the put option how you can earn money so maybe you can go back and see this video it will be helpful so basically but I’ll just say just basically if you’re if you’re expecting the market to be bullish then you want to buy a call option that is and if the market honors your view that will be profitable but if you are expecting the market to be bearish that is expecting the market to go down then you buy a put option and then it will be profitable of course this is this is just the what should I say this is the tip of the iceberg okay it’s not as simple as that.

 

ON BEING AN OPTIONS WRITER

What are your thoughts on being option writer?  My thoughts are very good on being option writer but you have to understand what it is like I said earlier option writing carries more risk than option buying so but if you understand the risk and if you are able to manage it if  what to do when things go wrong then option writing is a good strategy for consistent income okay but there is one caveat that I would like to give to you  in case of option sellers or option writers as they call  they say that  if the option writers eat like the chicken and poop like the elephant right so there are small consistent profits that you make but you when you go wrong  you can end up with huge losses so  probably like 6-8 months you are making profit and then one fine morning something happens  and you your view goes terribly wrong all of those six months profit can be wiped out so it is extremely important that you know what to do and more than that  how to adjust and manage your positions when things go wrong

So I do option writing and I do it consistently but I always hedge my positions I never sell naked positions so even if it is a buy position I always hedge my position I don’t keep naked positions so it is good to be option title if you want to if you’re looking at consistent income but then also there is a lot of risk see option buying is not safe it is risky so you cannot say that it is safe because you know you feel that  you are putting in very small amount of money but like I said earlier the return on investment is very high so if your return is positive it is very high if your return is negative also it is very high so compared to the capital that you are putting in your loss can be huge and  you keep on doing that keep on doing that you never know when you have actually lost actually a lot of amount

 

WHY OPTION BUYERS LOSE?

I would also like to tell you that most people who are losing in the option market are option buyers and that is majorly because they don’t understand what they are doing or it is also because maybe they are not able they are they don’t know how to manage positions if things go wrong okay and that’s why they end up losing a lot of money so  if when you say that  option buying is safe and limited risk all of that is theoretically true but the more and more that you do it a lot of your money can sink in  if you are not understanding what you do so I will not say that option buying is safe in fact option buying needs a lot of skill and precision okay because the momentum of the market plays a huge role in the prices of the option and momentum and time so that’s what we saw expiry date and price momentum it makes a lot of difference on the prices of the options and if you’re on the wrong side of the  if your view is on the wrong side you can end up losing a lot of money so I will not say that option buying is safe  it looks theoretically it looks like limited risk but over a period of time it can amount to a huge amount so  better be prepared and better be  knowledgeable before you take that kind of risks how much you invest is up to you

I mean like the amounts are pretty low to buy one lot but that doesn’t mean that  you go all out so if you’re starting I would say  set apart an amount   whatever is comfortable to you as per your budget set apart a small amount and then  start learning and there will be some people who are  great learners by doing things  unless you do it you don’t learn so there are some people who are like that so if you are like that person so  take one trade  and do it but  once again let me warn you don’t please don’t invest too much of money without understanding it so keep it a very small portion of your capital

 

Great okay so I think there are no more questions thank you for asking all those wonderful questions it was a joy sharing and  these are my contact points if you would like to get in touch would love to get in touch with you and thank you

Have a good day

Learn Options Trading – Basics for Beginners
Scroll to top