SHARETIPSINFO >> Articles Directory >>Basics of option trading and how to do option trading in Indian stock market

 

Option is one of the two most widely traded derivative instruments in the stock market. The option contract is traded between a buyer and seller for the underlying asset that can be stocks, bonds, future contracts, index futures and so on. An option contract means that the buyer of the contract has the right but not the obligation to buy or sell a fixed number of underlying assets at a predefined price within a fixed date. While trading in the option contract the buyer can exercise his buying or selling rights within the fixed date or he can let the contract expire worthless. But the seller of the option contract has the legal obligation to honor the trade when the buyer exercises the option contract within the fixed date. In option trading the assets are traded in a lot instead of one unit. The price for which the option contract is signed is called the strike price and the date on which the option contract is scheduled to expire is called the expiration date or expiry.

Types of option trading - There are two types of option contract the call option and the put option. When you are buying the call option you are having the right to buy the underlying asset in the strike price of the contract within the expiry date. When you are buying a put option you have the right to sell the underlying asset within the expiry date at the strike price.

In a typical option trading there are two persons involved in the trading- the buyer of the call or put option and seller of call or put option. The person who created the option contract is called the writer of the option. In case of call option he has the legal obligation to sell the asset and in case of put option he has the obligation to buy the asset. For buying the call option and the put option you need to pay the option writer the premium price of the contract.

Specifications of an option contract – There are certain information that is specified in any option contract. These are the specification or vital part of the contract on the basis of which the option is traded at the exchange between the two parties involved in the trading. The first thing that is mentioned in the contract is the type of the option contract. That means whether the buyer is having the buying right or selling right. On the basis of which it is determined whether it is the call option or put option. The next specification of the option contract is about the underlying asset of the contract. The type of the asset and the number of the units in the lot are mentioned in the contract. Apart from these information the strike price in which the contract will be traded and the expiry date on which the contract will get expired are also mentioned in the contract.

Types of options that are traded at the stock market – There are mainly two types of options and they are,

Exchange traded option - The exchange traded options are derivative that is traded at the exchanges. These options have standard contract and the contract is settled between the two parties through a clearing house. As these option contracts are standardized there are accurate price models for these contracts. The exchange traded options are available for different underlying assets including stock, commodity, bond, stock market index, and futures contracts.

Over the counter options – These contracts are traded between the two parties without the intervention of the exchange and hence these trades are not listed at the exchanges. As these options are not restricted by the clearing authority the specification of these contracts are determined according to term and requirements of the businesses concerned in the trading. The common types of options that are traded in these types are the interest rate options, currency cross rate options, and options on swaps.

Benefits of option trading – Option trading lets you enjoy greater leverage. That means with significantly smaller deposit you invest in asset that is of much higher value. Secondly in option trading you have less risk involved as you can always let the contract expire without any action if your speculation go wrong.

 

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