Options Trading for Beginners

Options trading is a type of financial trading, that allows investors the right to buy or sell an underlying asset at a fixed price, at a future date. This trading acts as a multi-purpose tool for hedging and increasing returns. Options trading for beginners can sound complex but it provides the flexibility of not purchasing a security at a certain date or time. This blog focuses on the fundamentals of options trading for beginners in India, including how to begin and successful techniques to employ.

What is Options Trading?

Options trading means buying or selling a financial contract that gives you the right, but not the obligation, to purchase or sell an underlying asset at a predetermined price by a specific date. This trading can be complex and requires knowledge to open an options account. To engage in options trading you need to have the skill of analyzing the market and making informed investment decisions. To avoid losses you should avoid options with low liquidity and should have proper risk management. Based on market conditions, use different strategies and explore various options trading approaches.

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How to Trade Options Using Four Easy Steps?

Here are the 4 easy steps for beginner's options trading.

Step 1: Open an Options Trading Account

Opening a trading account in your name is critical. Choose a suitable broker to open your account.  While looking for 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 stabilization, 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 judgments, 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 ₹ 5,100 by a certain date, you should buy a call option with a strike price less than ₹ 5,100. Your option will likely be profitable if the stock price exceeds the strike price. If the company's share price falls to₹ 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 helps you learn about several options trading methods.

Step 4: Analyze 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 as 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 Strategies for Beginners

The strategies mentioned below are straightforward and can be utilized by most beginners in options trading. However, more complicated techniques are available than merely purchasing calls or puts. Here is a quick overview of some more fundamental options for positions that would be ideal for individuals.

• 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.

How Options Trading Work?

Options trading involves a contract that allows you to buy or sell the underlying asset at a specific price before the contract expires. Traders buy call options if they expect the price to go up and put options if they anticipate a price drop. Profits depend on correctly predicting the direction of the asset's price movement.

Option Trading Example

Assuming the trader invests 10,000 in ABC, trading at about 200 per share, he 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).  It will be worth 30 a share (for a strike price of 230 to 200), totaling 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: 

What are the Levels of Options Trading for Beginners?

For beginners options trading, there are four primary levels. Let’s delve into each one. 

• 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 protective 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.