The securities market in India is about more than just stock trading. Although beginners tend to focus primarily on the equity market, other segments like derivatives are becoming popular. Options trading, which is a subject of derivatives trading, is particularly becoming a hotbed for retail trading activity.
In 2023 alone, 85 billion options contracts were traded in the Indian financial markets — which is more than the options trading volume in other markets across the world. However, despite the rising activity levels in the derivatives segment, many traders remain unsure of what options trading is and how it can become a profitable endeavour.
If you are also looking for answers to what options are, how they work, what options trading is and how you can successfully trade in the F&O market, this guide can be a great starting point for your journey.
What is Options Trading?
Options contracts are derivative financial instruments that obtain their value from an underlying asset — which may be equity stocks, currency pairs or commodities. Options trading is a technique that allows you to trade options contracts in the secondary market through the NSE and the BSE. This essentially means that you can buy or sell the right (but not the obligation) to trade the underlying asset at a specific price on or before a certain date.
While this sums up the core aspects of what options trading is, you should also get to know the types of options contracts. There are two main types of contracts: call and put options. A call option offers you the right to purchase the underlying asset. Conversely, a put option offers you the right to transfer or sell that asset.
To get started with options trading, you must understand the basic terms like the following:
- Strike price: The price at which you can buy or sell the underlying asset
- Expiration date: The last day the option can be exercised
- Options premium: The price of an options contract (which is affected by various factors including the asset’s current price, the strike price, time till expiry and the asset’s volatility)
Options can be used for different purposes. You can directly aim to profit from price changes in the underlying asset or even use options as a form of risk management tool to hedge against potential losses in your investment portfolio. Multi-legged options strategies combine the best of both worlds; they allow you to use call and put options to leverage price movements and simultaneously hedge one leg of the trade with another.
Before you start options trading as a full-time endeavour, it’s important to learn about the risks and rewards of buying and selling call and put options. While options can offer significant profit potential, they also involve a risk of loss — especially if the market does not move in the anticipated direction. To ensure you do not lose your capital, you need to have a well-thought-out strategy in place.
Options Trading can be More Complex and Nuanced than You Expect
The basics of what options trading is may make it seem like a simple trading segment, but buying or selling call and put options can be complicated and nuanced. This is primarily because you need to factor in a wide range of criteria to ensure that you do not lose your capital in the process of trading options.
Let us decode what makes options trading more complicated than trading in the cash segment.
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Options Pricing Mechanisms
It is essential to understand the basic mechanics of options, including call and put options, strike prices and expiration dates. However, this is just the starting point. You must also grasp how options pricing works; it involves the intricate interplay of the underlying asset’s price, time until expiry, volatility and interest rates.
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Market Volatility
The market’s volatility is another critical factor in options trading. It affects the premium (or cost) of an option — and higher volatility often leads to higher premiums. This is because the potential for price swings in the underlying asset increases the chance of the option becoming profitable. Therefore, predicting market volatility becomes a crucial aspect of strategy planning.
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Timing Options Trades
Timing is crucial in options trading. The value of options decreases as the expiration date approaches due to a phenomenon known as time decay. So, you need to anticipate the direction in which the asset’s price will move and also the timing of this movement. This requires a deep understanding of market trends, economic indicators and the specific factors influencing the asset’s price.
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Risk Management
You also need to manage the risk in options trading effectively. To do this, you can set strict limits on how much capital to risk on individual trades, use stop-loss orders to limit potential losses, and balance your portfolio with a mix of different options strategies to hedge against market fluctuations.
What Does it Take to Make Options Trading Profitable?
So, you now know what options trading is. But how do you make it profitable? Let us count the ways.
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Understanding Options Mechanics
A profitable options trading strategy starts with a deep understanding of how options work. You need to understand the differences between call and put options, how they work in different market conditions and the significance of strike prices and expiration dates. You must also grasp the relevance of intrinsic and extrinsic values of an option because they affect its price and potential profitability greatly.
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Market Research and Analysis
Effective market research and analysis are both equally vital. You need to study market trends, economic indicators and various other specific factors that influence the asset’s price. You should also perform technical analysis using charts and other tools to anticipate future price movements better and create strategies based on how the market may move by the option’s expiry date.
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Strategy Development
Once you factor in all the above aspects, you can move on to developing a clear trading strategy. This strategy should ideally be based on your risk tolerance, trading goals and market analysis. Common strategies to manage risk and capitalise on different market conditions include multi-legged approaches like iron condors, straddles, strangles and butterfly spreads. Each strategy has its own risk and reward profile, which should also be analysed before a trade.
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Strategy Analysis
Once you have narrowed down a few actionable strategies, you need to analyse different parameters to figure out the best among them. This means looking into the probability of profit, maximum loss and profit, risk level and margin required for each strategy. You should also evaluate the risk-reward proposition for each strategy to identify the approach that best aligns with your risk preferences.
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Strategic Execution
Profitability in options trading hinges on the strategic execution of trades. Timing is crucial because the market can be extremely volatile. Entering and exiting trades at the right moments can significantly impact profits. So, you need to be adept at reading market signals and executing trades swiftly to capitalise on fleeting opportunities.
Complex Options Trading Made Simple with Samco Securities
To improve the probability of success in your options trades, you need to account for all the factors outlined above. This can become nearly impossible to do manually. What’s more, before you complete the analysis for a given strategy, the market may move, rendering your strategy ineffective in the new market conditions.
Fortunately, Samco Securities has a solution to avoid the issue of missed opportunities. The brokerage firm has introduced Options BRO — a revolutionary options strategy builder in the Samco trading app. With this analytical tool, you can get the top 3 pre-built ready-made options strategies based on your market outlook. Additionally, Options BRO from Samco Securities also recommends hundreds of other suitable strategies.
You can even analyse and filter the strategies based on the probability of profit, maximum profit and loss, risk-reward ratio, breakeven price and the Samco risk-reward score, among other factors. Strategy execution is also easy because of the one-click trade feature in Options BRO — which allows you to instantly start trading in the options market.
