Options Trading Strategies for Beginners
Although the COVID-19 pandemic caused economic slowdowns almost all across the world, the Indian stock markets witnessed a stellar run during that period. As a result, both Nifty50 and SENSEX touched their all-time highs in October 2021. As a result, thousands of new investors entered the Indian stock market ecosystem during this period to grow their wealth.
As per the two depositories – the Central Depository Services (CDS) and the National Securities Depository Limited (NSDL) – the number of stock market investor accounts in India rose from 2.12 crores in March 2020 to 4.6 crores in September 2021. Out of these, almost 1.3 crore accounts were opened between the period of April 2021 to September 2021.
These novice investors usually look to invest in the cash segment only through equity shares and mutual funds. However, there is another method of trading in the stock market, called derivatives trading. Trading in derivatives allows you to make large profits by hedging against the asset classes and speculating market movements.
Futures and options are the two major types of derivatives trading in the stock market. In this article, we will discuss what is options trading and we will also tell you some useful options trading strategies for beginners like you. Let’s get started.
What is Options Trading?
Just like share trading involves buying and selling of shares, options trading involves buying and selling of options contracts in the stock markets.
Options are stock derivative instruments that provide the right, but not the obligation, to the buyer to buy or sell a specific quantity of underlying stocks at a specific price (known as the strike price) and on or before a pre-determined expiry date. Options contracts are legally binding documents with clearly defined terms and conditions.
Also Read: Financial Instruments Available For Trading
Based on whether they provide the right to buy or sell underlying stocks, options contracts are of two types:
- Call options
A call option gives you the right but not the obligation to buy a specific quantity of underlying stocks at a specific price on or before a pre-determined date in the future. You should buy a call option if you think that the price of its underlying security will rise in the future. A call option is profitable only if the price of the underlying security is higher than the strike price at the time of expiry.
- Put options
A put option is exactly the opposite of a call option. It gives you the right but not the obligation to sell a specific quantity of underlying stocks at a specific price on or before a pre-determined date in the future. A put option is profitable if the price of its underlying security remains lower than the strike price at the time of expiry.
Options Trading Strategies for Beginners
Options trading for beginners may seem a bit complex and risky. However, you can quickly learn and perfect this art by following a few simple options trading strategies mentioned below:
- Buying a long call or long put
This is one of the most common options trading strategies for beginners. In this strategy, a trader can buy a call option or a put option and wait till its expiry for the price of the underlying stock to cross the strike price.
By using the long call or long put strategy, you can make unlimited profits if the stock selected by you moves strongly in your direction before the expiry of your options contract. However, in case the opposite happens, your loss would be limited to the premium amount paid by you for buying the options contract.
- Covered call strategy
The covered call strategy is another useful options trading strategy for beginners. It consists of two parts – Firstly, a trader has to sell a call option, and secondly, they need to buy a certain quantity of the underlying stocks.
In case the price of the stock remains flat or even a touch below the strike price at the expiry, the call seller can keep the premium received from the buyer and also the stocks purchased by them. However, if the stock finished above the strike price at expiry, the call writer can sell their purchased stocks at the strike price.
- Married put
The Married Put strategy is similar to the long put strategy but with a twist. Here, the trader buys a put option but also owns a certain quantity of the underlying stocks. This works just like paying for insurance.
In case the price of the underlying stock falls below the strike price, the trader can benefit by exercising their put option. However, if the opposite happens, they will lose the premium but can gain from the stocks owned by them.
Although this strategy is meant for experienced traders, beginners can also try it. It involves buying a call option and a put option of the same underlying stock at the same strike price and with the same expiry date.
This strategy can be useful if you don’t want to predict the market but wishes to earn from price fluctuations. Whenever the market moves strongly in one direction, you will make profits.
Also Read: Stock Market Fluctuations
Although options trading allows you to make high profits in short periods, they entail high risks as well. So, you need to be well aware of the derivatives market and follow the suitable options trading strategies.
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Frequently Asked Questions
Several investors think that they must have a lot of money to trade in options. However, contrary to popular belief, you can start your options trading journey even with a small amount. The final amount depends upon the lot size, strike price, and the prevailing premium that you need to pay for it.
Yes. That’s true. Options trading is a bit riskier than investing in the cash segment. However, it also allows you to make large profits in small periods. You just need to be diligent and smart with your decisions. The good point is that you will know beforehand the maximum loss you can incur while trading in options.
To start trading in options, you need to first have a Demat and trading account. You can then visit the online platform of your stockbroker and search for the options chain in which you want to trade. Then, you need to select the strike price and expiry date and pay the premium to buy a call or put options.