Because of the pandemic situation, a lot of new and existing traders have been able to understand and learn this new craft of trading Options Trading. Nonetheless, as the skills and steps required to trade Options is not taught in schools or academics, most beginners find it difficult to learn how to trade options in India.
Therefore today, we are going to explain the step by step process on how to trade options in India in the easiest possible words. The most common concept that most of you must have heard about trading via options is the power to leverage. Leveraging in terms of Options trading would simply mean, the power to trade at higher capacity then what the direct value of trade would allow. Let us understand this with the help of a simple scenario from day-to-day life.
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Say, Ram has a wedding in his house two months down the line and for the purpose of the wedding, he needs to get grams of Gold. The current price of 10gms of Gold is Rs. However, Ram is a little skeptical about the volatility in the market and wants to lock in the current price of Gold, to be bought two months down the line. Therefore, with the objective of freezing the price of gold, he visits the jewelry shop and puts forward his proposition of buying the gold at the current price, two months down the line.
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But looking at the current volatility, the jewelry shop owner is a little skeptical of taking the risk of fixing the price of Gold. Therefore, to incentivize the Jewelry shop, Ram pays him certain token money say, Rs. Therefore, the total money paid by Ram to enter the agreement with the jewelry shop owner is Rs. However, if the price of gold after two months remains unchanged or goes down, then Ram is not obligated to honor the agreement.
He merely stands to lose the token money Rs. And that becomes the income of the Jewelry shop owner. For example, if the price of Gold were to increase to Rs. Now, if I were to relate this example to options, then the Ram is the Option buyer, the Jewelry shop owner is the option seller, Gold is the underlying asset, the current price of gold is the Strike price and token money paid is the option premium.
A similar scenario is also applicable to the stock market. Further, the premium paid might be an expense, however, if the share price goes way above the pre-decided agreement price, then the option buyer will make profits.
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To define in financial terms, Options are a derivative instrument that gives the right to option buyer to buy the underlying asset at a pre-decided price from the option seller, on or before expiry. However, the option buyer is not obligated to honor the contract upon expiry. He has the right to buy the asset if he chooses to. However, if he does not wants to buy in case the current price goes below the pre-decided value , he will simply lose the premium paid beforehand.
And the option seller is compensated in the form of this fee or premium to give up his right on underlying assets till the expiry of the contract. For the sake of reference and explanation, I will be using the trading portal of Zerodha Kite in this article, as it is the most commonly used trading platform in India.
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Following are the step by step procedure to trade options in India. Step 1: You need to have a trading account with one of the brokers For example, Zerodha , Angel broking , 5Paisa , etc. The steps to trade options in India are almost same in any trading platform you chose. Step 2: We need to have a margin in our trading to be able to trade options.
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Based on the position taken by the investor, the margin requirement varies. Option buyer needs margin to pay for the premium required to trade options. And option seller needs margin as they have to keep certain money with brokers to account for Marked to Market M2M. Step 3: Next, we need to understand as to what is our view on the underlying asset. If we have a bullish view, then we can buy a call option or sell put option and if we have a bearish view, then we can express the same by either buying a put option or selling a call option.
Step 4: Select the underlying asset you chose to trade and also select the various strike prices that we choose to trade upon. Now, say we are looking to trade Nifty 50 Contract via Option and we have a bullish stance on the market. An In the Money Option is one that would make money if we were to exercise it right now at current spot levels.
An Out of Money option is one that would be worthless if we were to expire it right now and an At the Money option is one that is the closest strike price to the current spot price levels. It is advised to not to go too out of money while buying an option as the chances of them expiring in the money by expiry, is very less and more often than not, they expire worthlessly.
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Then, the next step in this process is to place an order to buy the option. How to do option trading in Indian stock market. Option is basically an instrument that is traded at the derivative segment in stock market. Option is a contract between the buyer and seller to buy or sell a one or more lot of underlying asset at a fixed price on or before the expiry date of the contract.
While buying an option a contract the buyer has the right to exercise the option within the stipulated time period but he or she is not bound to exercise that option. On the other hand if the buyer is willing to exercise the option the seller is bound to honor that contract. In option trading the price that is agreed up on for trading is called the strike price and the date on which the option contract is going to expire is called the expiration time or expiry.
There can be different underlying assets for which options are traded including stocks, index, commodity, derivative instrument like the future contract and so on. Call Option — When you are buying a call option it will give you the right to buy the underlying asset at the strike price within the stipulated time period. The option writer, who is creating the call option, will have the obligation to sell the asset if you are willing to buy as per the contract. For buying the call option you will have to pay the premium price of the contract to the option writer.
Put Option — A put option is the opposite of the call option. When you are buying a put option it will give you the right to sell off the asset in the strike price on or before the expiry of the option contract.
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While you will have the freedom to either honor the put option or ignore it, the seller of the put option will be legally bound to buy the put if you are willing to sell. Trading in option contracts — For trading in the option contracts you have to pay the premium price to the writer of the option contract. Like in other forms of derivative trading in option trading as well you have to buy or sell the option contract for one or more lot. A lot comprises a fixed number of underlying assets and the price of the lot is determined by calculating current valuation of the asset in the market and the number of units in the lot.
From an investors point of view there are double folded benefit of option trading. Firstly, the leverage of the option trading that lets you control greater value of investment with significantly lower deposits. In option trading you need much lower deposits to trade in option trading than investing or buying the same quantity of asset outright.