Most beginners think buying call options (CE) when they expect the market to go up and buying put options (PE) when they expect some correction is all about options trading.
But the options trading is more than that. It is a versatile instrument that can be used to speculate, protect the capital, increase the returns on the capital, etc.
What are Options?
An option is one of the trading instruments in the capital market.
Options in the stock market are a contract that permits (but not mandatory) a trader to buy or sell an underlying stock or index at a predetermined price over a specific time.
A trader has to pay a small fee to buy these rights, and it is called the ‘premium’ of the option.
Call options (CE) Contract
A call option (CE) is a contract that gives the traders the right to buy the shares of a security at a specified price (strike price) until it expires.
If a trader is buying CE, he expects the price of the security to go up so that he can make a profit either by purchasing the shares at a predetermined lesser level or by selling the CE contract.
Buying call options (CE) is similar to buying insurance. If nothing happens and if you don’t claim any insurance, the premium is of no use.
Similarly, if the price of underlying security doesn’t go up (due to either a down move or a sideways move), the premium of the CE becomes zero at the end of expiry.
Put options (PE) Contract
A put option (PE) is a contract that gives the trader the right to sell the shares of a security at a specified price (strike price) until it expires.
If a trader is buying PE, he expects the price of the security to go down so that he can make a profit either by selling the shares at a predetermined higher level or by selling the PE contract.
If the price of underlying security doesn’t go down (due to either up move or sideways move), the PE premium becomes zero at the end of expiry.
Long vs. Short options
When a trader buys some shares of a stock anticipating the price will go up in the future, it is called the ‘Long’ position.
In contrast, when a trader sells some stock shares first (without having any position in the same stock), anticipating the price will fall in futures, it is called a ‘Short’ position.
But unlike stocks, if a trader buys CE (anticipating the price will go up) or PE (anticipating the price will go down), it is recognized as a ‘Long’ position in options (option buyer).
Suppose if a trader sells CE (anticipating the price will go down), or PE (anticipating the price will go up), it is recognized as a ‘Short’ position in options (option seller or option writer).
I hope this information helps!
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