In general, an investor’s portfolio consists of several asset classes which include stocks, bonds, mutual funds, ETFs and many others. Apart from these, there is another asset class – ‘Options’, which if used correctly holds the potential to offer handsome returns.
Options trading may seem complex and complicated, but it is easy to understand if you learn the basics right.
So, let us begin by first understanding what is an option?
What is an Option?
An “Option” is a derivative instrument whose value is based on underlying securities like stocks. Options contracts give the holder the right but not the obligation to buy or sell an underlying asset at a pre-determined price before the contract expires. The right to buy is known as “Call option” and the right to sell is known as “Put Option”. Just like any other asset class, options can be traded with the help of a demat account with the brokers.
Let us now learn what is options trading.
What is Options Trading?
When you participate in options trading, you will come across several terms that may sound new to you. Some of the common terms used in options trading are as follows;
It is the price that the buyer and seller pay to enjoy the benefits of an option contract.
- Strike Price / Exercise Price
It is the pre-decided price of the asset at which it would be bought or sold.
- Strike Price Intervals
The options contract can be traded at different strike prices, it is called strike price intervals.
The option trading is done by buying or selling the options at the premium. The premium is determined on the basis of the strike price. The expiry date of the contract also affects the premium price.
Let us now learn about the different types of options.
Types of Options
- Call Option
The “Call Option” gives the holder of the option the right to purchase an asset at the strike price on or before the expiry date. In return, the option holder has to pay an upfront premium to the seller. The value of the call option increases when the value of the underlying asset increases.
- Put Option
The “Put Option” gives the holder of the option the right to sell an asset at the strike price on or before the expiry date. In return the option holder has to pay the premium. In the put option if the spot price of the stock falls, the holder of the contract is protected against the fall right from the beginning. However, when the stock price rises, the put option holder loses only the premium amount and does not suffer a loss on the entire asset price.
Hope this article helps you learn the basics of options trading. In order to trade in options, you need to open a demat account with a reputed broker like Kotak Securities. The account opening process is very simple and quick.