Option trading is very popular in India, and as more beginners enter the financial market, it is becoming even more widespread. To benefit from options, it is essential to have a clear understanding of the basics of options trading and how it differs from equity trading. With this knowledge, you can make better decisions by choosing which is more suitable—options or equity.”
An option is a type of contract whose price fluctuates based on changes in the underlying asset.
With an options contract, you can buy or sell at a specific strike price. If the underlying asset moves in the direction you anticipated, you receive a reward.
Basic of option trading ; how it works
Options trading involves multiple strike prices and contracts with different expiration dates. For example, three-month contracts have varying premiums depending on their expiration period. If you purchase a contract close to the current month, the premium is lower. If you choose a later expiration, the premium increases. Each contract has a specific expiry date, and when one expires, a new contract for the next month becomes available.
One key difference between options trading and equity trading is how profits are made. In stocks, you can make profit when the price goes up. However, if you analyze the market and predict that a stock’s price will decline, you cannot take a position in equities.
Options trading provides an advantage in this scenario. If you are bullish on a particular stock or index—perhaps due to strong performance expectations or a positive upcoming event—you can buy a Call Option (CE). If the stock rises, you earn returns on your investment. Conversely, if you predict that a stock will be negatively affected by events such as poor earnings reports, you can buy a Put Option (PE). If the stock price declines, you make profit. This flexibility is why options trading is so popular and why every investor should understand it.
Expiry and Time Decay in Options Trading
Another critical aspect of options trading is that contracts are time-sensitive. Each strike price has an expiry date. In the case of index options, expiry usually occurs on the last Thursday of the month. If the stock price does not move as expected before expiry, the option’s premium will decay. If it does not reach its intrinsic value, the premium will drop to zero on the expiry date. This is a significant risk in options trading, unlike equities, which do not have an expiry.
Also read; Technical analysis; Difference between technical and fundamental analysis
Difference Between Equity Investment and Options Trading
Options trading differs from equity investment in many ways. In equity, you need to pay the full transaction value upfront. However, with options, you only need to pay the premium, which depends on factors like contract duration, expiration time, and strike price. there are the point who more differentiate the equity and option
Low Capital Requirement
In the case of options, there are strike prices and option contracts that have premiums accordingly. Below, you can see different strike prices with their respective premiums and contract sizes:
CMP – 2480
2600 Strike Price Premium = 8.65
Lot Size = 200
To take a position, you just need:
= 200 * 8.65 = 1730
With less than ₹2000, you can buy 200 quantities, whereas buying a single share of the company would require much more capital.
High Risk to Reward
Let’s assume you have ₹10,000 and, based on deep analysis, you expect the stock to increase by 10% in the near future. You want to maximize your position.
Equity Position
= 10,000 / 2480 = 4 shares
Option Position
= 200 * 8.65 = 1730
10,000 / 1730 = 5 lots
5 * 125 = 625
Here, you have 625 quantities.
If the stock moves up by 10% till expiry:
= 2480 * 10% = 248
New price = 2728
Equity Investment Profit
= 4 * 248 (total price movement) = 992
Option Position Profit
Intrinsic Value = 2728 – 2600 = 180
Final price after movement = 180 – 8.65 = 171.35
171.35 * 625 = 107,093.75 (profit)
This clearly demonstrates how equity positions differ from option positions. In the case of equity, you get only 4 shares with ₹10,000, whereas, with options, you control 625 quantities. If the premium is higher, you may get fewer quantities, but this example highlights the difference.
The Risk of Being Wrong
This example assumes you are correct, but what happens if you are wrong? If the stock does not move, your equity position remains intact. However, in the case of options, your position can become worthless, and your entire investment could be lost. This is why understanding the risks of options trading is crucial.
MTM (Mark to Market)
Options also provide an alternative to futures positions. If you buy futures, after paying the margin, you must also cover MTM adjustments whenever the stock moves against you. However, with options, you don’t need to worry about MTM. Many traders prefer buying in-the-money (ITM) or at-the-money (ATM) options to avoid MTM while positioning themselves for specific events or market movements.
why option is so popular
One of the most important reasons why option trading has become a popular instrument for traders is its high risk-to-reward ratio. In some cases, you can make money by investing as little as ₹500 to ₹50,000 in a single day. This potential for high returns attracts many traders seeking greater gains. Additionally, options have a low entry barrier and require relatively low capital, which sets them apart from other instruments.
Options also offer a variety of risk-to-reward ratios, allowing traders to choose investments based on their risk appetite and implement risk management strategies effectively. The presence of different contract sizes further helps traders manage their risk. Moreover, options are considered to have low time value, making them appealing for short-term trades.
To trade in options, you do not need any formal qualifications—only a demat account and a market view are required. This low entry barrier, combined with the high risk-to-reward potential, is the key reason behind the growing popularity of options trading
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