In this Article, we will discuss about OPTIONS in most simple Language. Nowadays everyone wants to do Options Trading and trust me its very exciting.Instead of telling definition of Options, in this Article I will teach you what you need to know for doing Option Trading.
Important terms in case of Option Trading:
- Strike Price
- Expiry Date
- Lot Size
So, we will understand each of the above Segments one by one and trust me in the end , everything will look very simple.
Segments of Options Trading
Options Trading can be done in Stocks or you can do Options Trading in Index like Nifty & Bank Nifty. In this Article we will take Stock Options and once we learn basics of Options in next Article we will take Index Options.
Options Trading in Stocks or Stock Option Trading
As the term suggest, in Stock Options Trading we are going to trade in Stock Options.
Lets take an example now:
For Example: We have a Option like this : TCS JULY 3400 CE or TCS JULY 3400 PE
Which Stock we are taking about ?
In the above example we are talking about TCS stock.
What does JULY means in this example ?
JULY here means that this Option is for July Month.
What do we mean Expiry Date ?
When we say the stock option is of July Month means this Option is going to Expire on the Last Thursday of the July Month, please note which ever Thursday will be the last Thursday will be expiry date of that Stock Option and hence Stock Options have Monthly Expiry.
What do we mean by Strike Price ?
Now in the above example , if you notice we are talking about TCS stock for July Expiry for the Price of 3400 , so this 3400 is the Strike Price.
What does CE and PE mean here ?
What is this CE at the end of the Stock Option: CE means Call and PE means PUT.
What does Call and Put means ?
Call means you want the Stock to go up and PUT means you want Stock to go down
What we Understood till now ?
So, till here we understood that we have a TCS Stock Option for July Month for Strike Price 3400 and we either have a CALL or PUT – But what does all that means to me ?
Now, let’s assume you bought TCS JULY 3400 CE at Premium of 50 Rs , but hey what is Premium ??
What do we mean by Premium ?
Premium, is the Price you Pay to buy this Stock Option, its just like for buying Infosys stock you need to pay the price of the stock similarly for buying Stock Option you need to pay Premium.
So now Read Carefully, we are Buying TCS 3400 CALL Option for July Expiry and we are Paying Premium of 50 Rs .This means now if TCS starts moving up you will be making Profit. But how is it calculated and is that so simple ?
What is Lot Size ?
Every Stock Option has its Lot Size. When you buy a Stock you can buy one share or 1 crore shares it depends on your choice , but in case of Options every stock options has its own lot size for example in our case TCS stock option has a Lot Size of 300 .
How Much Money is Invested to Buy this TCS Option ?
You are Paying 50 Rs for each one share of TCS option, so total money we need to invest for buying this Option is 50×300= 15000 (this amount can change as well , so you can check margin calculator for the broker you use).
When we will start making Profit – Most Important Question.
For Example, you took the TCS July 3400 CE at 50 Premium on 3rd July and last Thursday of the July Month is falling for example on 29th July, now on 29th July TCS stock closed at 3600.
How is the Profit Calculated in the above Case:
Since you took TCS Call Option of 3400 Strike and TCS Closed at 3600, so you were correct by 200 points, means you thought TCS will go up above 3400 but till where it will go you didn’t know but it went till 3600, so the Premium of TCS JULY 3400 CE will become 200 on expiry day.
How is the Premium Calculated at the Time of Expiry ?
Its simple the Price it closed on Last Thursday in our case TCS Closed at 3600 minus the strike price you choose which in our case was 3400 , so the difference is 200 and that will be the final Premium.
Still what is my final Profit ?
Premium you Paid for Buying this TCS JULY 3400 CE was 50 and now the Premium is 200 , so you gained 150 Points of Premium .
Nice , so means my profit is just 150 Rs ?
No your profit is the Premium Gained multiplied by the Lot Size which in our case is 300 , so our Profit is 150×300= 45000 Rs.
So, you Paid 15000 Rs and you made Profit 45000 Rs , this is the Power of Options , if you and your view is correct at the end of Expiry you can make a lot of Money.
But what if what if TCS Closed below 3400 on Expiry date ?
If TCS Closed below 3400 on Expiry date, what will happen to your Option , in this case since your view went wrong and TCS closed above 3400 at the expiry day hence your Investment of 15000 becomes 0
What if TCS Closed at 3430 on Expiry date ?
What if TCS Closed at 3430 on Expiry date, what will happen to your Option, in this case even though your view of TCS closing above is correct , but TCS just closed 30 points above the strike price you selected which means the Premium at the time of Expiry become 30 Rs but you paid 50 Rs Premium , so here also you made a loss of 20 premium points which means 20×300 = Rs 6000 Loss.
So, it means if TCS closed above 3450 you start making Profit.
What if TCS moves to 3600 in mid July and comes back below 3400 at the time of Expiry ?
If TCS moves to 3600 in mid July and comes back below 3400 at the time of Expiry then also you loose all your investment because at the end of expiry TCS closed below 3400
Can we sell TCS option before Expiry ?
Can we sell TCS option before Expiry for example when it went up till 3500 or 3600 , yes you can sell it anytime you like or when you see Profit or Loss, you can sell before expiry anytime or at expiry.
If you don’t sell at Expiry then automatically the Premium gets settled as discussed above.
This was the basics of Options Trading which every trader should know, there are many other Concepts in Options which we will cover in the coming articles, if you want to understand Options in more details watch the below Video: