Option Trading

1. Introduction to Options

In the world of financial markets, investors and traders are always looking for instruments that allow them flexibility, leverage, and opportunities to manage risks. One of the most popular derivatives that provide such opportunities is options trading.

An option is a financial contract between two parties: a buyer and a seller. The buyer of the option gets the right, but not the obligation, to buy or sell an underlying asset (like stocks, indices, or commodities) at a predetermined price within a specified time. The seller (also called the option writer) has the obligation to fulfill the contract if the buyer decides to exercise it.

This feature—right without obligation—is what makes options unique compared to other financial instruments.

2. Basic Terminology

Before diving deeper, let’s clarify some key terms:

Call Option: Gives the buyer the right to buy the underlying asset at a fixed price (strike price).

Put Option: Gives the buyer the right to sell the underlying asset at a fixed price.

Strike Price: The pre-agreed price at which the buyer can buy or sell the underlying.

Premium: The cost paid by the option buyer to the seller for the right.

Expiration Date: The last date the option is valid.

In the Money (ITM): When exercising the option is profitable (e.g., stock price above strike for calls, below strike for puts).

Out of the Money (OTM): When exercising leads to a loss, so the buyer won’t exercise.

At the Money (ATM): When the stock price is very close to the strike price.

3. How Options Work – An Example

Suppose stock ABC Ltd. is trading at ₹100.

You expect the stock to rise.

You buy a Call Option with a strike price of ₹105 for a premium of ₹3, expiring in one month.

Scenario 1: Stock rises to ₹115

You exercise your right to buy at ₹105 and immediately sell at ₹115.

Profit = (115 – 105) – 3 = ₹7 per share.

Scenario 2: Stock stays at ₹100

Buying at ₹105 makes no sense, so you let the option expire.

Loss = premium paid = ₹3.

This shows the limited loss (premium only) but unlimited profit potential for an option buyer.

4. Types of Options Trading Participants

There are broadly four categories:

Call Buyers – bullish traders expecting price rise.

Put Buyers – bearish traders expecting price fall.

Call Sellers – take opposite side of call buyers, hoping price stays flat or falls.

Put Sellers – take opposite side of put buyers, hoping price stays flat or rises.

Buyers take on risk by paying premiums, while sellers assume obligations but earn premiums upfront.