Options buying is an investment strategy that allows individuals to participate in the financial markets without directly owning stocks. It’s a way to bet on the future price movements of stocks, indices, or commodities. However, it does not involve the obligation to purchase or sell the underlying assets.
In this article, we’ll break down options buying in simple terms. This article explains what options buying and how it works.
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What Are Options?
Let’s first understand what options are. Options are financial contracts. They give the buyer the right to buy or sell an asset (like a stock) at a preset price within a specific period (expiry). However, they do not pose any obligation to the buyer.
They are derivatives, meaning their value comes from the value of an underlying asset. Investors can trade options on various assets. These assets include stocks, indices (like the Nifty or Sensex) and commodities (like gold or crude oil).
Option Buying: What Is An Underlying Asset?
As the name suggests, there is an underlying asset for every option. In Indian markets, it is easy to know what is the underlying asset for an option. For instance, if you’re buying BANKNIFTY 46000 CE, it means the underlying asset of this option is BANKNIFTY. It means that if BANKNIFTY moves in the positive direction above 46000, you’ll be gaining profits and vice versa.
It simply means that if you buy an option for a particular stock, that stock is the underlying asset.
Two Types of Options: Call (CE) and Put(PE)
1. Call Options
A call option gives the buyer the right to purchase the underlying asset at a given price within a time limit. This time limit can be weekly or monthly.
It’s like making a reservation to buy a stock at a set price in the future. Investors typically use call options when they believe the underlying asset’s price will rise.
2. Put Options
A put option grants the buyer the right to sell the underlying asset at the strike price within a specific period. It’s like having insurance against a drop in the stock price. Investors use put options when they anticipate that the underlying asset’s price will fall.
How Options Buying Works
Options buying involves purchasing call or put options with the hope of profiting from future price movements. Here’s how it works:
1. Choose an Underlying Asset: Decide which stock, index, or commodity you want to bet on. Do your research and analyse its price trends and market conditions.
2. Decide Your Strategy: Decide whether you want to buy call options or put options (if you expect it to decline). Use your analysis for this.
3. Select an Expiry Date and Strike Price: Options have expiration dates, after which they become worthless. Choose an expiry date that aligns with your price expectations. Also, select a strike price that reflects your prediction of the asset’s future value.
4. Pay the Premium: To buy an option, you need to pay a premium to the seller (the writer of the option). The premium is the price of the option contract. It varies based on factors like the asset’s fluctuations, time until expiration. The difference between the strike price and the current market price also affects it.
5. Wait and Watch: Once you’ve bought the options, monitor the price movements of the underlying asset. If the price moves in your favour before the expiry date, you can choose to exercise the option (if it’s profitable). Otherwise, sell the option contract for a profit.
Benefits of Options Buying
Options buying offers several advantages for investors:
1. Limited Risk: If the stock price declines, options buying allows you to limit your risk to the premium paid for the option contract. This is not the case with stock trading.
2. Leverage: Options buying provides the potential for higher returns with a smaller initial investment. Options require only a portion of the capital to buy the underlying asset. Thus, they offer leverage, increasing potential gains.
3. Variations: Options buying allows investors to profit from both rising and falling markets. Whether the market is bullish, bearish, or stagnant, there are options and strategies available to capitalise on different scenarios.
4. Expansion: If done in the right market conditions and at the right time, your capital can manifold with limited risk. Options buying can also help diversify your risk and hedge against potential losses in other asset classes.
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Risks of Options Buying
While options buying can be lucrative, it also carries inherent risks:
1. Limited Time: Options have expiration dates. If the price doesn’t move in your favour before the expiry, the option may lose its value entirely.
2. Fluctuations: Market fluctuations influence options buying. High “volatility” can increase options premiums, making them more expensive to buy.
3. Tough-To-Understand: Options trading involves understanding various concepts. They include strike prices, expiration dates, and option Greeks (like delta, gamma, theta, and Vega). These can be daunting for beginners.
4. Potential Losses: If the price doesn’t move as expected, one can lose the entire money paid for the option contract.
Why Do Indians Do Options Buying?
Over 90 per cent of the traders in the market have less amount of capital to start with. After the margin-benefit regulations have changed, these traders with less amount of capital look for other options. They seek options where they can make the most amount of money without having a lot of it.
Eventually, these investors end up choosing options buying. But the rosy picture seldom holds true that 98 per cent of the options buyers are loss makers. As per SEBI data, the average loss amount is more then INR 50,000.
Conclusion
Options buying can be an exciting way to participate in the financial markets. One can potentially earn profits from price movements without owning the underlying assets.
Always remember to consult with a financial advisor and practice responsible investing habits to achieve your financial goals. One of the key things to remembering while doing option buying is to utilize the disposable capital. This is because the markets are ruthless and do not care about one’s money. If not used carefully, markets can erode life-long savings.
However, it’s essential to understand the risks involved and conduct thorough research before diving into options trading. With proper knowledge, strategy, and risk management, options buying can be a valuable addition to your investment toolbox.
FAQ
What Are Options ?
As the name suggests, there is an underlying asset for every option. In Indian markets, it is easy to know what is the underlying asset for an option.
Why Do Indians Do Options Buying?
Over 90 per cent of the traders in the market have less amount of capital to start with. After the margin-benefit regulations have changed, these traders with less amount of capital look for other options. They seek options where they can make the most amount of money without having a lot of it.
How Options Buying Works ?
Options buying involves purchasing call or put options with the hope of profiting from future price movements. Here’s how it works:
Sir plz make a learning video on Greeks.