Some Concepts to Understand Before You Start Trading in Options: CALL and PUT Options
Trading in options can seem complex at first, but with a solid understanding of the fundamental concepts, it becomes much more accessible. Options trading involves making predictions about the market movement, and this article will help demystify some key concepts to help you make informed decisions.
1. Betting on Market Direction: CALL and PUT Options
Think of options like bets placed in a game or casino. When you buy a CALL option, it’s akin to placing a bet that the market will rise. Conversely, buying a PUT option is like betting that the market will fall. Just like in sports betting, if your prediction is correct, you profit, and if it’s wrong, you face a loss.
2. Expiry: Time-Bound Predictions
Every bet has a time limit, and options are no different. Expiry refers to the timeframe within which you need to predict the market’s behavior and buy the appropriate options. In index option trading, there are two main expiries for Nifty and Bank Nifty: weekly (every Thursday) and monthly (last Thursday of the month). The last Thursday expiry essentially serves as both a weekly and monthly expiry.
3. Weekly vs. Monthly Expiry
Understanding the difference between weekly and monthly expiry is crucial. Weekly options are more volatile compared to monthly ones. This means that the potential for both earnings and losses is higher in weekly expiry due to faster and more significant price movements.
4. Time Value: The Clock is Ticking
As an option approaches its expiry date, its price starts decreasing at a faster pace. This phenomenon is known as time value. The closer the expiry date, the more rapidly the option’s price reduces.
5. Strike Price: Defining the Playing Field
Strike price represents a predefined level of the index price. In the case of Nifty 50 index options, strike prices are available at regular intervals, such as 19000, 19050, 19100, and so on. Options become “in the money” (ITM) or “out of the money” (OTM) based on the movement of the index price in relation to the strike price.
– ITM and OTM in CALL Options
When the index price surpasses the strike price, the corresponding call option becomes an “in the money” (ITM) call option. Conversely, if the index price falls below the strike price, it’s termed an “out of the money” (OTM) call option.
– ITM and OTM in PUT Options
For PUT options, the situation is reversed. An option becomes “in the money” (ITM) when the index price falls below the strike price. Conversely, if the index price rises above the strike price, the option is now “out of the money” (OTM).
6. Getting Started with Practical Trading
It’s normal to feel a bit overwhelmed, but focusing on one type of option at a time can help. Begin with call options and gradually move to put options as you gain experience.
7. Understanding Lot Size
Lot size refers to the number of shares you need to buy or sell. In index options, you typically trade in multiples of fixed share quantities. For instance, in Nifty 50, the lot size is 50 or 100 shares, while in Bank Nifty, it’s 15 shares. Starting with selection criteria for call options can make it easier to grasp these concepts.
8. Practical Example: Nifty 50 Call Option
Let’s walk through a simple trade:
- Index Price (Nifty 50): 19241 on 23-08-2023
- Expiry: Weekly (24th Aug 2023)
- Strike Price: CALL Option – 19250 (1st OTM) or 19200 (1st ITM)
- Lot Size: 1 lot (50 QTY)
- Approximate Capital Needed: Rs 5000/-
In conclusion, options trading can be a lucrative endeavor once you grasp these foundational concepts. Remember that learning by doing is often the best approach, so start with small trades and gradually build your understanding and confidence.
FAQs
- Q: Can I trade options without understanding these concepts? A: While it’s possible, understanding these concepts greatly improves your chances of success and informed decision-making.
- Q: How much capital do I need to start trading options? A: Capital requirements vary, but starting small is advisable. The example provided requires around Rs 5000/-.
- Q: Is options trading riskier than traditional investing? A: Options trading can be riskier due to the leverage involved, but with proper knowledge, risk management, and strategy, it can also be rewarding.
- Q: Can I change my option trade once I’ve executed it? A: Some platforms allow modifications before expiry, but it’s important to understand the terms and conditions of your trades.
- Q: Where can I learn more about advanced options strategies? A: Numerous resources, books, and online courses are available for those looking to delve deeper into options trading strategies.