In the year 2000, the derivatives market was established in India. “It is a source of great pride for us and our country that the NSE has emerged as a global leader and achieved the distinction of being the largest derivatives exchange in the world for the third consecutive year and the fourth largest exchange in cash equities by the number of trades,” NSE MD & CEO Vikram Limaye said. Options are one of four derivatives traded on the Indian Stock Exchange.
The equity derivative market in India trades index futures and options. Buyers can exercise options to acquire or sell an asset at a defined price and date. Trading options necessitates a more in-depth strategy. The procedure of creating an options trading account is really simple. All you need to do is provide an extra document, such as a 6-month bank statement, a copy of your ITR, a wage slip, or a demat holding statement.
Before we get into the techniques, it’s important to understand how options vary from stocks.
All futures and options have an expiration date, after which they no longer exist or may be traded. Shares of stock, on the other hand, have no expiration date and can be kept indefinitely. This implies that while selecting alternatives, you must select a time range for your position.
A striking price is also associated with options. This implies you can purchase or sell equities at the strike price using the option. A share at price X can also be acquired at price X. However, the real value or premium of a price Y option must be multiplied by the lot size. Index options, such as the nifty and bank nifty, have a constant lot size, although lot sizes vary by stock trading in the derivative section.
Did you know that risk-averse traders use options to boost their total returns? Investors that are optimistic on a stock purchase call options so that they may use the leverage. Some traders buy call options in order to get better selling prices. They can sell calls they want to get rid of. If the price increases over the strike price of the call, they can sell the shares and keep the premium as a bonus.
Futures and index options expire on the final Thursday of each month. For example, if you purchase a futures contract on March 2, 2022, the contract will expire on March 26, 2022, the final Thursday of the month. The closing price or settling price is always the cash market closing price. Listed equity options contracts, on the other hand, are frequently paid by delivery of the real underlying shares of stock.
The inherent value drops as the option’s value grows. Options that are in the money ITM or out of the money OTM have the highest intrinsic time value. Time value is highest when the option is in the money, in the money, and at the beginning of the month, or the more days before the contract expiry date, the higher the option price.
The reason for this is that at this point, the potential for intrinsic value begins to increase. When an option hits maturity or expiry date, its value begins to decline. This is known as theta decay. An option can be exercised at any moment, even if it is nearing its expiration date. Option premiums tend to rise and fall extremely fast as the expiry date approaches, depending on the underlying asset’s market price. Traders just profit from price change at any moment in time. The higher the premium, the deeper the contract. However, if the option loses its intrinsic value, the premium falls. On expiry, the price of all out-of-the-money contracts becomes 0 (zero).
Is there any impact of corporate activity on options?
Corporate events such as stock splits, dividends, mergers and acquisitions, rights issues, and spin-offs can have a significant influence on a company’s stock price. Corporate behaviors reveal a great deal about a company’s intentions regarding its shareholders and others. They are an issue of the company’s reputation and goodwill. They cause changes in the futures and options of the equities affected by the business activity.
Let’s look at what options beginners may do to reduce their risks using these four fundamental option strategies: long call, covered call, long put, and short put.
Long call traders wait for the stock price to rise or exceed the strike price before the option expires. This allows the trader to gain many times their initial investment.
The sky is the limit for the upside on a long call. If the stock increases before expiration, the call price may rise more. However, if the stock closes below the strike price, the call expires at zero, and the trader loses all of the money he has invested in that Nifty intraday tips.
As a result, traders employ this approach only when they believe the stock will climb before expiration.
A covered call is a call that is sold with the option of also purchasing the underlying stock. This allows the trader to convert a potentially dangerous deal into a comparatively safer, income-generating one. In this case, the trader anticipates that the strike price will be higher than the stock price before expiry. In the contrary event, the owner will have to sell the shares on the open market.
The advantage of this option strategy is that the call is restricted to the premium even if the stock price rises. However, if stock prices fall dramatically, the trader will be out of money.
When you currently own the stock and do not expect its price to rise in the future, use this option strategy (selling call). This method converts your existing ownership into an income stream. You can earn the premium because it will be zero on the expiry date. The only downside is that individual investors with fewer shares (fewer than the derivative lot size) should avoid selling calls against their holdings since derivatives have a set lot size.
In this approach, the trader purchases options and expects that by the expiry date, the stock price will have fallen more drastically than the strike price and his paid premium. If the stock declines, the advantage of this trading method is the opportunity to multiply the initial investment.
Selling stock is actual delivery, but selling naked puts raises the trader’s risk. If the stock falls below the strike price before the option expires, the trader suffers a net loss. When you expect the stock to decline considerably before the option expires, a long put is a solid alternative.
The trader sells options and anticipates that the stock price will be higher than the strike price by the expiration date. In return for selling the put, the trader receives a cash premium. If the stock closes at or below the strike price, the trader purchases it at that price.
The maximum return on a short put, like the covered call, is what the seller receives upfront. In the event that the stock falls to zero, the entire value of the underlying stock less the premium obtained is the strategy’s inverse. It is feasible to close the trade prior to expiration and suffer the net loss without purchasing the shares.
When you plan to buy a put or a call option, you should understand how your actions will affect the option’s price. Option pricing, independent of market moves, seem to have a life of their own. However, you will quickly notice that volatility is the most common culprit.
Understanding the impact of volatility on option pricing behavior can help you mitigate losses or add value to successful bets. The challenge is to grasp the link between volatility fluctuations and the underlying equities.