What is an option and how do you do it
An option is a security, like a stock or an index or a commodity, that you buy and sell within a fixed time frame. Let’s understand this in simple terms.
In an option, you are given a specific time limit. It could be a week or a month. After that period, the contract expires, and a new contract becomes active. In a weekly contract, you get a strike price. For example, if a stock price is ₹100, you have to analyze and predict whether this stock will go from ₹100 to ₹150 or from ₹100 to ₹50 within a week, and then you buy or sell accordingly.
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Note: In options, you can trade stock options, index options, or commodity options like gold, silver, crude oil, etc.
An index is a solution created by exchanges. If we want to monitor what various stocks are doing, we would have to search for each one individually. To solve this, the exchange grouped stocks from the same sector and gave them an index name. For example, all financial stocks are grouped into one index, and the same is done for IT stocks, automobile stocks, green energy stocks, etc.
There are two main stock exchanges in India: BSE (Bombay Stock Exchange) and NSE (National Stock Exchange). BSE is a very old stock exchange.
Options trading is very risky. If you don’t learn everything properly and backtest your strategies, you will definitely lose money. This is because in options, you can lose money just as quickly as you can make it. You should only start options trading after you have 5-6 years of experience in the market and are consistently making a profit.
The most important thing in options is the Greeks.
Delta
Delta tells you how much the premium of a stock can increase or decrease when its price goes up or down. For example, a stock is currently trading at ₹220, and you bought its option for a premium of ₹40. If the stock goes from ₹220 to ₹230-240, the premium will also increase. Delta tells you how much that premium will increase.
Gamma
Gamma tells you how fast the delta will change as the stock price goes up or down.
Theta:
Theta measures time decay. For example, you bought a stock option for a premium of ₹40 for a week (weekly contract). As the week gets closer to its end, that premium starts to decay.
Vega
Vega tells you about a stock’s volatility. In simple terms, it indicates how much the stock’s price will fluctuate.
What is an Option Chain?
An option chain is a tool that tells option sellers and buyers about the market sentiment. In simple terms, an option chain shows the available puts and calls for a stock or index, their strike prices, and their expiry dates. The option chain contains a lot of information that helps option buyers and sellers understand the market.
An option chain provides data about sellers because sellers make the most money in the market. They don’t just buy options. While option buying requires very little money (you can start with as little as ₹5,000), option selling requires lakhs of rupees. Option sellers make a fixed amount of profit, meaning their profit is predetermined, but their losses are not.
Option buyers, on the other hand, can make unlimited profits, and their losses are limited. In simple terms, if a buyer invests ₹5,000, their maximum loss is only ₹5,000. But if a seller invests ₹1 lakh and the trade fails, they could lose their entire ₹1 lakh and potentially more. However, sellers’ losses are very rare because they plan their trades with a strong strategy after thoroughly analyzing the market. Option sellers are much smarter than buyers. If you also learn to analyze and create the right strategy like a seller, your trades can also become profitable.
The put/call data
The put/call data in the option chain is the sellers’ data. Let’s understand this with an example. Suppose Nifty 50, our index with 50 stocks, has a price of ₹25,500. You bought a weekly contract on July 1st. Now you need to check the option chain to see the Open Interest (OI) for the current price’s call and put options. OI tells you how many people have bought options at that strike price. This helps you understand which direction the market is likely to move. It is also important to know where the liquidity is, but we will discuss that in detail in the next chapter.
Note: Don’t be in a hurry to learn options. It is a very complex and patience-demanding topic. You should not trade options until you have learned everything because if you start trading, you will lose money, and then you will trade again to recover that loss. This cycle will continue repeatedly.
Therefore, it is very important to learn about gamma, the option chain, the mindset of sellers (i.e., market sentiment), and market trends and to apply the right strategies. Otherwise, you will not be able to survive.i