Options Trading - A Complete Guide on Options Trading Online | Espresso

Options Trading

All of us want options in various facets of life, do we not? Whether it is the options for food items on our platters or options for subjects to choose from at school or college, having the ability to choose between multiple courses of action has a certain thrill and power attached to it.

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When we seek options in almost all aspects of our lives, why should stock trading be any exception?! This is where options trading comes in.

What is Options Trading?

Options trading is trading in derivative contracts that confer upon the holder the right to buy or sell a security at a predetermined price at a pre-decided date in the future. These contracts, commonly referred to as options, are written by sellers and agreed to by buyers who are also termed as options holders.

In exchange for the aforementioned option, the seller charges a fee from the buyer. Termed premium, this charge is the maximum loss that the option holder suffers if they decide not to exercise the option. On the other hand, this premium amount also serves as compensation for the sellers of options in the event of buyers not exercising their contractual right to buy or sell.
Also Read: Best Options to Trade

What is Strike Price in Options Trading?

In options trading, the strike price or exercise price is the price at which the buyer or options holder agrees to buy or sell the underlying asset at a future date. This price remains unaltered irrespective of the market price of said asset on the date of the execution of the contract, which is termed as the 'Expiry Date'.

Types of Options in Options Trading

There are two main types of options in options trading, namely:

Put Option

A Put Option confers upon the buyer of the options contract in options trading the right to sell the underlying asset at a pre-decided price and date.

Call Option

A Call Option gives the buyer of an options contract in options trading the right to buy the underlying asset as per the agreed-upon date and price.
Know More about Call Put Options

Pros and Cons of Options Trading

Pros of Options Trading

Cons of Options Trading

Options trading is cost-effective since the buyer of the option needs to pay the seller the premium at the time of entering into the contract. The final settlement is done at a later date only should the buyer choose to exercise their right to buy or sell.

Options contracts have a high amount of commissions associated with them, thereby increasing the overall cost of the contract for the buyer.

Since the margins for options contracts are low, the buyers of options contracts enjoy a considerable degree of leverage.

There is a time decay for options contracts, which means that as the contracts expiry date approaches, the value of the option keeps diminishing.

There is a low level of risk associated with options trading since, unlike futures contracts, the buyers of options contracts are not obligated to uphold the buy/ sell contract. The exposure of an options holder is largely restricted to the premium paid by them to the seller.

Options contracts and options trading strategies tend to be complex since there are many factors to be considered in choosing and exercising said strategies.

There is a wide variety of options strategies that can allow traders engaged in options trading to make profits.

In options trading, the option holder generally has a low level of liquidity. There is a very low chance that the option you hold will have a high volume in the market, considering the seemingly endless permutations and combinations of strike prices and expiry dates available for the option of each optionable stock.

Options Trading Strategies

There is a multitude of options trading strategies at the disposal of traders, particularly in stock trading. The best options strategy for different traders varies, depending on their risk appetite, leverage, and the underlying asset and price trends thereof.

Here are some of the most popular stock option strategies that you can apply in options trading:

1. Covered Call: In this options strategy, the seller of a call option holds an equivalent amount of the underlying asset. By selling a call option on the asset, they can cover their long position and also earn some income through the premium amount on the option.
Know More about Covered Call in Option Trading

Should the buyer/options holder exercise their call option, the seller can deliver the underlying asset. If, however, the option remains unexercised, the seller still profits from the premium income. It also reduces their risk in a long-term long strategy for the underlying asset.

2. Married Put: In the stock options strategy of Married Put, a trader who holds a long position on a particular asset purchases a put option on the same asset to have the option to sell the asset should its price decrease. Although the purchase of a put option carries a premium, it allows the trader to still have the flexibility to benefit from a price appreciation whilst covering their potential losses.

In Conclusion

Options trading can enable you to hold multiple trading positions on the same asset and have all your bases covered. However, options contracts are complex, which is why you should be completely aware of their minutiae and your risk appetite.
Also Read: Futures Trading

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Frequently Asked Questions

An 'In-the-Money Option' is an option that enables the options holder to make a profit should they decide to immediately exercise said option. Such a situation materialises when the current price of the underlying asset is higher than the strike price mentioned in a call options contract.

There is a fundamental difference between an American Option and a European Option. Whilst the former allows the options holder to exercise their right to buy or sell the underlying asset in an options contract at a predetermined price at any time on or before the expiry date of the contract, the latter allows for the exercise of the option only on its expiry date.