Options trading is a type of derivative trading where its price is intrinsically linked to an underlying stock. A stock buyer holds the right, but not the obligation, to buy/sell 100 shares of a stock at a premium from/to a seller within a fixed time period.
What is Options Trading?
Options trading is done by people who are not heavily interested in stocks and hence do not hold them. With options, buyers and sellers (or writers) of the options speculate the price rise or fall or the underlying stock and take their respective positions. Options are also used by large fund managers to hedge their positions and reduce the risk of capital erosion in a volatile market.
How are options different from stocks?
- Options contracts have expiration dates. In India, the options contracts expire on the last Thursday of the month. You can also buy/sell options for three months from the current month.
- Stocks hold an absolute price value whereas the price of the options changes depending on the changes in the price of the underlying stock.
- Owners of options contract do not have a right over a company, unlike stock owners.
Types of Options
When a trader speculates the price of a stock to rise, he will trade with the call options. At the time of purchase, the buyer has to pay a premium to the seller which gives him the right to buy the stock at a specified price.
A trader who trades with put options anticipates a drop in the price of the underlying stock. Similar to the call option, the seller has to pay a premium to the buyer to get the rights to sell the options at a specific price called the strike price.
Stay tuned for more about the basics of options trading.