by In this article, I am going to answer a fundamental question that is what are the stock options basics? you’ve heard about call options put options you might be curious to learn what they are and you know what even if you have experience with options it’s always good to review these things.
So this article is not just for beginners, experienced traders will also get more information from this article. I’ve seen a lot of posts and articles but none of them really gave satisfying answers. So I decided to write an article with my own experience.
Stock Options Basics for Trading
What is stock options ?
A stock options trading is a contract giving the contract buyer the right but not the obligation to buy if it’s a call option or sell if it’s a put option shares and it’s usually a hundred shares of an underlying asset and the underlying asset can be a stock like a Reliance, Bajaj Finserv or Hdfc Bank, etc, or it could be an ETF or exchange-traded funds it could be a commodity and if you don’t know about exchange-traded funds don’t worry about that right now we’ll just pretend that it’s stocked for the sake of simplicity we’ll just talk about stocks.
What is Call Option?
If it’s a contract giving the contract buyer the right to buy a hundred shares then it’s a call option which is also known as a call. so throughout this article, I might call it a call option or a call or a call option contract.
They all mean the same thing it’s the right to buy a hundred shares of a stock or ETF or commodity or whatever.
What is Put Option?
If it’s a contract giving the contract buyer the right to sell a hundred shares then it’s a put option which is also called a put and again in the whole article, I might call it a put option or I might just call it a put or a put option contract.
They’re all names for the same thing which is the right to sell a hundred shares these options contracts specify a particular price at which the contract buyer can buy if it’s a call.
For sell if it’s a put the underlying assets they also specify an expiration date you know how milk as expiration dates or coupons has an expiration date yeah so if the contract buyer wants to exercise the option he or she would need to do so by the expiration date.
When I say exercise the option remember a call gives you the right to buy a hundred shares of a particular stock at a particular price and by a particular date and so you have to do it by the specified expiration dates and a put gives you the right to sell a hundred shares at a particular price by the expiration date.
Stock Options Trading with Example
let’s look at an example we’ll talk about reliance stock. let’s say you bought a Rs 2000 call talking about buying one call option here for reliance that means you would have the right to buy a hundred shares of reliance stock at a Rs 2000 per share at any time on or before last Thursday of the month. So after the last Thursday of the month, your contract is finished and you don’t have the right to buy a hundred shares of reliance stock at a Rs 2000 share anymore.
If you bought a hundred shares of reliance stock at Rs 2000 that means your total would be Rs 200000 and you know obviously if you wanted to buy it either you have to have Rs 200000 in your trading accounts or investment account or else you could have a margin account which means you can borrow money from a broker or bank.
If you don’t understand that that’s okay just know that July 2000 reliance call would give you the right to buy a hundred shares of reliance stock. if you wanted to and you wouldn’t have to on or before last expiry day of the month for a Rs 2000 a share.
One thing to know about option contracts is that the buyer of the art of the contract doesn’t have to exercise the contract. If you bought one reliance call you would have the right to buy a hundred shares of reliance stock if you wanted to do that but if you chose not to buy the 100 shares then you wouldn’t be obligated to do.
This seller is also called the writer of the call contract because remember when you bought it, somebody had to sell it to you. The seller of the call contract on the other hand would have an obligation to sell the 100 shares of reliance stock to you if you asked him to do so before the expiration date which you could do by exercising the option contract.
If you bought the contract from him he would have the right to sell it to you at any time you could ask him to do it anytime until the expiration date in exchange for the burden of this obligation that the option seller has you click on the call contract buyer would have to pay the premium or the price of the contract to the call option seller.
If you’re the buyer you would pay the contract seller or the options seller, you pay him a little bit of money because he’s taking on an obligation. You’re paying a little bit of money called a premium for the right for that right to buy a hundred shares of reliance stock before the expiration date.
let’s go back to the reliance example, let’s say you bought one reliance call with an expiration date of the current month, and let’s say the call option gave you the right to buy 100 shares of reliance stock at a Rs 2000 per share. So again that would be Rs 200000 all together we would then say that Rs 2000 is the strike price.
The strike price is the price at which you have the right if you’re the buyer of the option you have the right to buy the reliance stock. Now let’s also say that reliance stock is currently worth Rs 2000 per share.
So right now it’s trading on the open stock market at a Rs 2000 per share for reliance stock and let’s say that you paid Rs 200 per share for the call option contract remember that’s called the premium that’s what you’re paying for the right to buy the reliance stock.
One contract represents 100 shares of the stock so that means you paid Rs 20000 for the call option contract that’s the premium that you paid. if Rs 20000 sounds like a lot of money consider that if you were to directly purchase a hundred shares of reliance stock it would cost you Rs 200000 because remember right now we’re pretending that it’s available on the open market at Rs 2000 per share.
If you bought reliance stock right now a hundred shares at Rs 2000 each then it would cost you Rs 200000 which is a lot more money than the Rs 20000 premium for the call. if you think paying for an option contract is expensive it’s very little compared to buying stock buying a hundred shares of stock would cost you a lot more than buying one option contract as the call buyer you’re hoping that the price of reliance which in this case is the underlying asset.
You’re hoping that the price of reliance goes up in price before the expiration date in this case it’s the expiry day of the current month. For example, if reliance stock went up to Rs 500 per share by the expiry day of the current month. Imagine if you bought that call option with a strike price of Rs 2000 and then imagine if reliance stock went up to Rs 500 per share then you could exercise your contract and the guy who sold you the call contract would have to sell you a hundred shares of reliance you would pay Rs 20000 and then you could go to the open market and turn it around and sell it for sell those hundred shares for Rs 500 and you would make a Rs 300 profit per share.
So your total profit would be Rs 100000 now, of course, you would probably pay fees and commissions but still, you would profit pretty close to Rs 100000 that’s not too bad in fact it’s pretty good.
Now, what about the seller well meanwhile whoever sold you the call would probably be unhappy he or she the seller of the call would have to acquire or already have owned a hundred shares of reliance which is now Rs 100000.
So if they didn’t already own a hundred shares of reliance stock they have to go on the open market and buy it for Rs 200000 and then sell those hundred shares to you for Rs 20000 and so if they had to go and buy a hundred shares of reliance for Rs 100000 and then sell them to you Rs 20000 that person would lose an eighty thousand rupees and similarly it goes on there will always be an equal number of buyers and sellers at the market then only one can buy those stock and sell those stock.
Always choose volatile stock where you can trade easily while seeing some candlestick patterns, day trading patterns, swing trading patterns, or price action then you can initiate your positions as per the patterns.
Conclusion
Stock options basics for day trading are usually the best basics to learn from scratch, here we had covered the Stock Options Basics. One should follow the Risk Management, Money Management, and Fear and Greed concept of the market to avoid big losses in stock options trading.
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