Options Trading for Beginners

Options Trading for Beginners

When you trade options, you buy or sell an underlying asset at a predetermined price by a specific future date.

Trading stock options is more complicated than trading stocks. When you purchase a stock, you specify the number of shares you desire, and your broker fills the order at the current market price or a limit price you choose. Options trading necessitates an awareness of sophisticated tactics, and creating an options trading account entails a few extra procedures than opening a standard investing account.

What is Options Trading?

Options trading is the process of selling or acquiring a certain asset at a predetermined rate and date. This sort of trading necessitates a full grasp of how to create an options account, as well as several complex tactics and cautious trading. It is also critical to understand how to trade options since not knowing how to do so might lead to large losses. 

Stock options trading is often more difficult than stock trading. This is because purchasing stock allows you to select the quantity of shares you want. When trading options, however, there are other aspects to consider. You must also understand the distinction between the future and alternatives. 

Options are generally divided into two categories of contracts: put and call. A put option allows the buyer to sell the underlying asset at a pre-determined price in the future. A call option, on the other hand, gives the contract buyer the right to acquire the underlying asset at a pre-determined price in the long run. This is often referred to as the strike rate. This is why understanding options trading for beginners is critical. 

When market circumstances are unfavourable, options might assist in creating revenue. It can also help protect against negative outcomes. That is why learning to trade options may help you get closer to profiting mindfully.

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Table of Content

  1. What is Options Trading?
  2. How to Trade Options using Four Easy Steps? 
  3. Options Trading Strategies for Beginners
  4. Option Trading Example
  5. Advantages and Disadvantages of Options Trading
  6. What are the Levels of Options Trading?

How to Trade Options using Four Easy Steps? 

Here are the 4 easy steps on how you can trade options:

Step 1- Open an Options Trading Account

Starting to trade options is not the final aim, but having a trading account in your name is critical. Options trading is more complicated than stock trading and may necessitate substantial funds. Brokers seek to learn about investors holistically to guarantee they are appropriate for this form of trading. Options trading for novices in India may be difficult. While interviewing a broker, provide information about your investing objectives, capital speculation, income growth, and understanding of investments and options trading. Answer truthfully and intelligently to assist them in understanding your trading experience. Discuss the most effective options strategy and present personal financial information and the types of options you want to select depending on your preferences.

Step 2- Pick the Options

The direction of the underlying stock's movements influences the option selection. Consider whether to sell a call or put option for stock price stabilisation, sell a put option for high stock price expectations, or acquire a put option but sell a call option for low stock price expectations. To make educated selections, you must use options trading examples and seek expert advice from financial consultants. This will allow you to obtain in-depth knowledge on the subject and make a better-educated decision. By making these judgements, you will be able to make sensible investing options.

Step 3- Predict the Options Strike Price

Option purchases are only valid if the stock price is below or above the strike price at the end of the expiry period. Buying an option with a strike price corresponding to your stock projection is critical. For example, if you expect a firm's share price to rise to Rs. 5,100 by a certain date, you should buy a call option with a strike price less than Rs. 5,100. Your option will likely be profitable if the stock price exceeds the strike price. If the company's share price falls to Rs. 2,500, you should buy a put option with a strike price higher than this. If the strike price falls, your option is likely to be profitable. This procedure teaches you about several options trading methods.

Step 4- Analyse the Time Frame

Options contracts feature an expiry date that indicates the last day for usage. Understanding futures and options trading is critical for novices because the options are confined to delivery dates. Expiry dates for options can range from weeks to years, with daily and weekly options riskier for experienced traders. Long-term investors prefer monthly and yearly payments. 

Long expirations provide more time for stock movement, making them useful for novices. Longer expirations are more expensive, but they can help you keep time value even if the stock trade is below the strike price. The temporal value of options decays as the expiration date approaches, but option buyers cannot watch the value of their acquired options decline.

Options Trading for Beginners

 

Options Trading Strategies for Beginners

The strategies discussed here are simple and may be used by most inexperienced traders or investors. However, more complicated techniques are available than merely purchasing calls or puts. While many of these techniques are described elsewhere, here is a quick overview of some more fundamental options for positions that would be ideal for individuals who are comfortable with the ones discussed above:

  • Married put strategy: The married put, like a protective put, entails purchasing an at-the-money (ATM) put option in an amount sufficient to cover an existing long position in the stock. In this regard, it resembles a call option (also known as a synthetic call).
  • Protective collar strategy: An investor with a long position in the underlying purchases an out-of-the-money (i.e., downside) put option while simultaneously writing an out-of-the-money (upside) call option for the same company.
  • Long strangle strategy: A strangle is a trading method in which a buyer concurrently owns an out-of-the-money call and put option with the same expiration date but separate strike prices. The put strike price should be lower than the call strike price, necessitating a smaller premium yet requiring the stock to go either higher or downward to be profitable.
  • Vertical spreads: Vertical spreads comprise purchasing and selling options of the same kind and expiring date at various strike prices, either bull or bear. When the market rises or falls, they benefit. Spreads are less expensive than long calls or puts because they include the option premium from the sold option. This, however, restricts the potential upside to the distance between strikes.

Option Trading Example

Assuming the trader invests 10,000 in ABC, trading at about 200 per share, they could buy 50 shares for 10,000. If the stock price rises by 15% to 230 in the next month, the trader's portfolio will increase to 11,500, resulting in a net return of 1,500, or 15%, on the money invested.

Now, consider a call option on the stock with a strike price of 200 that costs 8.50 per share or 850 per contract. With the trader's available budget, they could purchase six options for 5,100. Investing in 600 shares (since one option contract controls 100 shares), if the stock price rises 15% to 230 at expiry, the option will expire in the money (ITM) and be worth 30 a share (for a strike price of 230 to 200), totalling 18,000 on 600 shares. This yields a net return of 12,900, or 253% on the money invested, significantly higher than trading the underlying asset directly. 
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Read more about Options Trading vs Intraday Trading.

Advantages and Disadvantages of Options Trading

Here are the advantages and disadvantages of options trading: 

Advantages of Options TradingDisadvantages of Options Trading
1. High Return Potential: Options can yield higher returns compared to stock trading, providing an opportunity for increased profitability.1. High Commissions: Options trading often involves higher commission fees, impacting overall returns.
2. Variety of Strategies: Options markets offer numerous strategic combinations using put and call options with different strike prices and expiration dates.2. Less Liquidity: Some options may lack liquidity, challenging executing trades at desired prices.
3. Cost-effectiveness: Options allow investors to acquire positions equivalent to stocks at lower margins, making it a cost-effective alternative.3. Non-Availability of Stock Options: Certain stocks might not have options available for trading, limiting investment choices.
4. Risk Management: While inherently risky, options can help manage risks effectively when used strategically, offering ways to mitigate potential losses.4. Time Decay: Options contracts lose value over time, impacting their worth, especially for longer-term holdings.

What are the Levels of Options Trading?

For beginners options trading, there are four primary levels. Let us learn more about each of them. 

Level 1: Protective puts and covered calls. When an investor already owns an underlying asset, this is the case. 

Level 2: Both puts and calls are very long. Strangles and straddles are involved. 

Level 3: Consists of the acquisition of one or more options. Currently, selling one or more options on the same underlying asset occurs concurrently. 

Level 4: Options contain naked options, which have the potential for significant losses. Without a prior understanding of these four stages of trading, options trading for novices may be risky. 

Conclusion 
Options provide investors with different ways to profit from trading underlying securities. Several techniques use various combinations of options, underlying assets, and other derivatives. Purchasing calls, purchasing puts, selling covered calls, and buying protected puts are all basic techniques for novices. There are benefits to trading options rather than underlying assets, such as downside protection and leveraged gains, but there are also drawbacks, such as the upfront premium payment required. Choosing a reliable stock market app is the first step in trading options.

FAQs on Beginners Options Trading

Although most novices believe that options trading is dangerous in the beginning, it may be rather handy if they have a proper understanding of this subject. In reality, it may be a valuable investment instrument for all sorts of newcomers who want to learn more about this industry. 

Yes, you can start option trading with 1000 rupees, but it's advisable to start with caution due to the high risk.

Study through online courses, books, tutorials, and practice with virtual trading platforms to learn more effectively.

Although there are several options trading techniques to pick from, you must choose the one that is most valuable to you. A straddle appears to be the most effective options trading method.

Options trading works in much the same way as equities trading. This form of trade can take place at any time during market hours. Monday through Friday are the market hours. The hours are 9.15 a.m. to 3.30 p.m. IST. So, to minimise discomfort, make sure you trade accordingly.