In the recent few years, the Indian derivatives market has seen a tremendous increase in option trading activity. The F&O segment of the National Stock Exchange (NSE) has a daily turnover of more than 4 lakh crores, with index option operations accounting for more than 80% of that.
Because of its own profile, the option segment has grown in popularity in recent years. Trading activity in this category is fast increasing since it provides the possibility to profit from all types of market mood, whether bullish, bearish, range bound, or highly volatile.
Aside from the cash market, where shares can be bought and sold, the exchange also has a futures and options market where these stocks or indices can be bought and sold. A futures contract is an agreement to buy or sell an underlying stock or index at a predetermined price at a specified time in the future while an option is a contract that gives the buyers the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a certain date.
Option buyers must pay a premium in order to obtain the right but not the obligation, limiting risk in the event of a market collapse while increasing reward in the event of a market rise. Because option sellers earn this premium, their risk is unrestricted, while their profit is limited to the premium price, they receive for this option contract.
Advantage of Option trading which make it more profitable, as well as causes for increased trading volumes.
Option buyers’ perspective: – Option buyers just have to pay the premium, therefore the investment to obtain a contract is significantly cheaper than the investment to obtain a future contract.
– Risk is limited and maximum to the premium amount, regardless of market conditions.
– Protective Puts can be used to hedge a long-only delivery portfolio.
From the perspective of option sellers: – They benefit from range bound market movement because if it remains in a range, the premium declines due to the property of option contracts;
– They benefit from premium eating because deep out of the money option strikes are quoting at a premium and there is a high probability that these premiums will head towards zero;
– They reduce the cost of positions already taken in portfolios or future contracts by selling out of the money Calls.
Options and options trading: Myths and Facts
Options are too dangerous: Options are dangerous only if we don’t know how to use them. The danger for the buyer is limited to the premium amount, whereas the risk for the naked seller is significant. As a result, it necessitates correct market judgement or hedging strategy, which decreases risk and is the beauty of the option segment. Risk is an inevitable element of life and trading, and one must learn how to hedge against it using one’s own instrument and customised tactics.
The options are difficult to comprehend: Options are not difficult to comprehend on their own. Investors essentially have the right to buy or sell an underlying stock at a certain price. Even better, investors only have two choices: Call or Put, and investor can purchase or sell. If investors are a newbie, investor should adhere to simple methods like the Collar, Ladder Spread, Iron Condor, Strip, Strap, Butterfly, Calendar Spread, Box, and so on.
Selling options is similar to receiving free money: Nothing in this life is free, especially when it comes to trading. There is a common misconception that selling options is almost risk-free. Although it appears like selling options for cash is a secure technique, selling naked or uncovered options is a risky strategy because the risk is unlimited. The majority of the time, option sellers’ profit; nevertheless, when unskilled investors do not manage risk effectively and with discipline, the few losses can be disastrous.
Option sellers are the only ones who profit: The truth is that both option buyers and sellers can profit from option trading. There would be no buyers if only sellers made money, and there would be no market if there were no buyers. Option buying has a distinct advantage in many situations, particularly when the market is volatile, moving, or directional.
It’s simple to earn money using options: Making money in the market necessitates being smarter than the competition, as it’s a zero-sum game in which one must lose if the other must win. So, it’s not as simple as it appears. It takes a lifetime of hard work, dedication, and attention to learn how to trade and invest properly. Trading and investing according to investor’s personal risk tolerance, time horizon, and investment goals with adequate risk-reward management and discipline is the key to finding and maintaining a high level of success in the markets.
There is a widespread belief that option trading is extremely dangerous. Options aren’t always dangerous. Depending on investor’s risk tolerance, investor can choose options that are less dangerous or riskier. It can be used for speculation, hedging, protection, and leverage, among other things. There are many ways to profit from options, and we believe that the beauty of options and bespoke option strategies would help to increase trading activity in the Indian derivatives market.
Written By – Sudha Swaroop