Part 1 Support and Resistance

Part 1: Introduction to Options

Options are a derivative financial instrument, meaning their value is derived from an underlying asset like a stock, commodity, index, or currency. Unlike buying the actual asset, options give you the right—but not the obligation—to buy or sell the underlying asset at a predetermined price (strike price) before or on a specific date (expiry).

The core advantage of options lies in their flexibility and leverage. A trader can control a large amount of stock with a relatively small investment—the premium paid. Options are widely used for three main purposes:

Speculation: Traders bet on price movement of the underlying asset.

Hedging: Investors protect their portfolios against adverse price moves.

Income Generation: Selling options can provide regular premium income.

Options are classified based on exercise style:

American options: Can be exercised any time before expiry.

European options: Can only be exercised at expiry.

Example: Suppose a stock trades at ₹100, and you expect it to rise. You could buy a call option with a strike price of ₹105. This option allows you to buy the stock at ₹105, even if it rises to ₹120. If the stock never crosses ₹105, you only lose the premium paid.

Options are highly versatile. They can be used to profit in bullish, bearish, or sideways markets, making them more dynamic than regular stock trading. However, they are also riskier because the time-sensitive nature of options (time decay) can erode profits if the market doesn’t move as expected.

Part 2: Types of Options
Options come in two basic types:

1. Call Option

A call option gives the buyer the right to buy the underlying asset at the strike price. Buyers benefit if the asset price rises above the strike price plus premium. Sellers, called writers, have the obligation to sell if the buyer exercises the option.

Example:

Stock Price: ₹100

Strike Price: ₹105

Premium: ₹5

Break-even for buyer = Strike + Premium = 105 + 5 = ₹110. Profit starts above ₹110.

Profit Calculation for Call Buyer:
Profit = Max(0, Stock Price – Strike) – Premium

2. Put Option

A put option gives the buyer the right to sell the underlying asset at the strike price. Buyers profit if the asset price falls below the strike price minus premium. Sellers have the obligation to buy if the buyer exercises.

Example:

Stock Price: ₹100

Strike Price: ₹95

Premium: ₹3

Break-even = Strike – Premium = 95 – 3 = ₹92. Profit starts below ₹92.

Profit Calculation for Put Buyer:
Profit = Max(0, Strike – Stock Price) – Premium

Part 3: Option Terminology
To trade options effectively, understanding terminology is crucial:

Strike Price (Exercise Price): Price at which the option can be exercised.

Premium: Cost of buying the option. It depends on intrinsic value, time value, volatility, and interest rates.

Expiration Date: Last date an option can be exercised.

In-the-Money (ITM): Call: Stock > Strike, Put: Stock < Strike. Profitable if exercised immediately.

Out-of-the-Money (OTM): Call: Stock < Strike, Put: Stock > Strike. Not profitable if exercised immediately.

At-the-Money (ATM): Stock ≈ Strike Price. Usually has highest time value.

Intrinsic Value: Value if exercised now (Stock – Strike for calls, Strike – Stock for puts).

Time Value: Additional premium due to remaining time until expiry.

Premium Formula:

Premium = Intrinsic Value + Time Value

Example:

Stock = ₹120, Call Strike = ₹100, Premium = ₹25

Intrinsic Value = 120 – 100 = ₹20

Time Value = Premium – Intrinsic Value = 25 – 20 = ₹5

Time decay reduces this value daily, especially for options close to expiry.

Part 4: How Options Work

Options trading involves buying and selling contracts:

Buying a Call Option

Expectation: Stock price will rise.

Loss is limited to the premium.

Profit is unlimited if the stock keeps rising.

Example: Buy call with strike ₹105, premium ₹5, stock rises to ₹120.

Profit = 120 – 105 – 5 = ₹10

Buying a Put Option

Expectation: Stock price will fall.

Loss is limited to the premium.

Profit = Strike – Stock – Premium

Example: Buy put with strike ₹95, premium ₹3, stock falls to ₹85.

Profit = 95 – 85 – 3 = ₹7

Writing Options

Writing calls: Seller gets premium, but risk is unlimited if stock rises sharply.

Writing puts: Seller gets premium, but risk is significant if stock falls.

Options are exercised or expired:

Exercise: Buyer uses the right to buy/sell.

Assignment: Seller fulfills the obligation.