Part 1 Support and Resistance

1. Introduction to Options Trading

Options are financial derivatives that give traders the right, but not the obligation, to buy (Call Option) or sell (Put Option) an underlying asset at a pre-decided price (strike price) within a specific time frame. Unlike shares where you own the asset, options provide flexibility to speculate, hedge, or generate income. Options derive their value from underlying assets like stocks, indices, commodities, or currencies, making them versatile but also complex.

2. The Nature of an Option Contract

Each option contract has four key elements:

Underlying Asset (e.g., Reliance stock, Nifty index).

Strike Price (predetermined buy/sell level).

Premium (price paid to buy the option).

Expiration Date (last valid trading day).
This structure allows traders to choose different risk/reward setups, unlike shares where profit and loss move linearly with price.

3. Call Options Explained

A Call Option gives the buyer the right to purchase the underlying asset at the strike price. For example, buying a Nifty 20,000 Call at ₹100 means you expect Nifty to rise above 20,100 (strike + premium). If it rises, profit potential is unlimited, but loss is capped at ₹100 (the premium paid). This asymmetry makes calls powerful for bullish strategies.

4. Put Options Explained

A Put Option gives the buyer the right to sell the underlying asset at the strike price. Example: buying a TCS ₹3500 Put at ₹80 means you profit if TCS falls below ₹3420 (strike – premium). Put buyers use it for bearish bets or hedging existing long positions. Loss is capped to premium, profit grows as price declines.

5. The Role of Option Writers (Sellers)

Every option has two sides: the buyer and the seller (writer). Writers receive the premium but take on significant obligations. A call writer must sell at strike price if exercised; a put writer must buy. Sellers have limited profit (premium received) but potentially unlimited losses (especially in calls). Option writers dominate because most options expire worthless, but the risk is substantial.

6. Intrinsic Value and Time Value

An option’s premium has two parts:

Intrinsic Value (IV): Actual profit if exercised now. Example: Reliance at ₹2600, Call strike at ₹2500 → IV = ₹100.

Time Value (TV): Extra premium due to potential future price movement. Near expiry, TV decays (time decay).
Understanding IV and TV is crucial for identifying overvalued/undervalued options.

7. Option Expiry and Settlements

Options in India (like Nifty, Bank Nifty) have weekly and monthly expiries. Stock options have monthly expiries. On expiry, in-the-money (ITM) options settle in cash (difference between spot and strike). Out-of-the-money (OTM) expire worthless. Expiry days often see volatile moves as traders adjust positions.

8. The Concept of Moneyness

Options are classified by their relation to the spot price:

In the Money (ITM): Strike favorable (e.g., Call strike below spot).

At the Money (ATM): Strike = spot.

Out of the Money (OTM): Strike unfavorable (e.g., Call above spot).
Moneyness influences premium, risk, and probability of profit.

9. Option Premium Pricing Factors

Option premium is influenced by:

Spot Price of the underlying.

Strike Price.

Time to Expiry.

Volatility (Implied & Historical).

Interest Rates and Dividends.
The Black-Scholes model and other pricing models quantify these variables, but in practice, demand-supply and implied volatility dominate.

10. The Greeks – Risk Management Tools

Option traders use Greeks to measure risk:

Delta: Sensitivity to underlying price.

Gamma: Rate of change of Delta.

Theta: Time decay impact.

Vega: Sensitivity to volatility changes.

Rho: Sensitivity to interest rates.
Greeks help traders build and manage complex strategies.