All you need to know about the Options Contracts [Derivatives Market]

Types of Options

Options can be classified into two types, namely Call option and Put option. Let us discuss about them in detail.

1. Call Option: A call option is a contract which gives the call owner the right to buy or sell any security or underlying asset at a specified price within the predetermined time frame. It must be noted that it is only a right and not an obligation.

To buy a call option you need to pay the option premium. As we have discussed, it depends on the option owner that he wants to exercise the option or not. However, the seller is obliged to sell the underlying asset to the buyer. In case of a call option there are limited losses in form of options premium, but the profits can be limit less.

Call Options can be further classified in the following two types:

a) In the money call option – In this case, the strike price will be lower than the current market price of the underlying asset.

b) Out of the money call option – In this case the strike price will be more than the current market priced of the underlying asset.

2. Put Option: A put option is just the opposite of a call option as it gives the owner the right but not the obligation to sell a specified amount of underlying security at a pre-determined price within a specified time frame. This pre-determined price which the buyer of the put option can sell at is known as the strike price.

2. Advantages of Options Contracts

There are many advantages of Options, which make them one of the most preferred choice of investors. Some of the main advantages of Options Contracts include:

• Cost Efficiency: Options are usually traded using high leveraging power. You can trade in options with a far lower capital when compared to stocks. For instance, to purchase 100 equity stocks of certain company at 80 Rs, you will need 8000 Rs. However, you can purchase call options of equal weightage you will only need 2000 Rs upfront. Thus, options contracts are very cost efficient.
• High potential of returns: The returns on trading in options is very high when compared to trading in shares in the cash market. Options pay equal profit as simple stock buying if the right strike price is chosen. Since you are earning same profit by investing far lower capital, the return percentage would be higher.
• Low Risks: You must be wondering that options are riskier when compared to equity stocks, but you should also know that at times, option contracts are used to avoid risks. These contracts are often used for hedging. In case of options the risks are usually pre-defined because the maximum loss in case of options will be the premium paid for buying the same.
• More Strategies Available: Options trading has various strategies in market when compared to other derivatives or cash market. For example, you can combine various trades and create a strategic position with the help of call and put options having different strike price and expiry dates.

2. Disadvantages of Options:

We have already observed that trading in options contract can prove out to be highly rewarding. But before you step into the world of options, it is important to know about the disadvantages or drawbacks of options trading as well. Some of the major drawbacks of trading in options are:

• Less Liquidity: There are chances that some of the stock options have a very low liquidity which can make it very difficult for a trader for entering or exiting from the position.
• High Commissions: Trading in options is costlier when compared to futures trading or trading in stocks. Most of the brokers charge a higher fee for trading in options when compared to other investment instruments.
• Time Decay: Time decays is one of the worst things you can experience while trading in options. The value of your options premium will decline by some per cent each day irrespective of the movements in the underlying asset.
• Non availability of all Stock Options: Each and every stock which is listed on the stock exchanges does not necessarily have options contracts. Therefore, it is difficult for you to hedge every position using option contracts and strategies.

Options contracts make use of leverage and therefore they are considered a high-risk instrument. You can take the help of Equity Derivative Pack for getting research based recommendations for all your derivative trading needs. If you want to use swing trading strategies in your derivatives trading, you can useM Delta Derivative Plus. Also, you should get your risk profile evaluated from a SEBI registered investment advisor before investing in any of the investment instruments to have an idea about your risk bearing capacity.