How trading is done on options (calls and puts)
There are various ways and methods to earn money from options.
Traders adopt their own ways which ever fulfills their requirements and needs.
a) Buying naked call or put
b) Short selling of calls and puts
c) Bullish Techniques - coming soon..
d) Bearish Techniques - coming soon..
a) Buying naked call or put
Naked calls and puts means traders do not hedge (or buy other side calls/puts to reduce the risk).
Hedging means buying other side calls and puts to reduce the risk if market turns against your trade.
Naked Call will be bought when the trader is expecting the underlying (either stock or Index) will go UP.
Naked Put will be bought when the trader is expecting the underlying (either stock or Index) will go DOWN
Buying Naked calls and puts provides unlimited profits and limited losses.
If trader uses hedging then further losses can also be reduced.
In the below example let’s see how trading is done on Naked calls and puts taking into consideration various trading scenarios
As a example - Let's say Nifty Index is currently trading at 3000 and a investor/trader purchases
One call option of Nifty Index at a price of Rs 50 whose strike price is at 3100 and expiry at 29 April 2009
So the total cost required to purchase one lot of Nifty call comes to Rs 2500 (Rs50 x 50 quantity)
This is also called as premium. This is your maximum loss you have to accept if the nifty falls down.
While the profits are unlimited as long as Nifty index keep going upside, especially once Nifty crosses 3100 which is your strike price.
Note - Each options contract represents one lot. Either you take it stock or Index.
So in our case one lot of Nifty Index consist of 50 quantities of Nifty.
Following are different scenarios will show how the Nifty Call Option will provide profits and losses.
First Scenario - If Nifty index rises to 3050.
Your profit is Rs 2500 ( Rs 50 x 50 qty) for one lot of Nifty Index.
Second Scenario - If Nifty index falls to 2950.
Your loss is Rs 2500 (Rs 50 x 50 Qty) for one lot of Nifty Index.
This is the maximum loss the trader has to pay.
Third Scenario - If Nifty Index falls below 2950 then no need to square off your call option.
No need to do anything, your option gets automatically expires at the end of the month and your maximum loss is RS 2500 which is your premium paid while buying the call.
Forth Scenario - Hedging your Call option
From above example you came to know that your maximum loss is Rs 2500 but if you want to reduce this loss, further, then you can hedge your call.
At the time of buying call you can buy one Nifty Put of strike price 2950.
So if Nifty starts falling below 3000, your call value starts decreasing while your Put value starts increasing
So over all when Nifty falls below 2950 your loss in call will be Rs 2500 (which is maximum) while you will get some profit in 2950 put. So your losses are reduced.
On the other hand if the nifty rises above 3050 then your put value decreases and your call value increases. So in this case your profit will be reduced.
b) Short selling of calls and puts
Short selling Calls
Call is bought when the underlying is expected to go up and the short selling of call is done when the underlying is expected to go down.
Short selling requires future derivative margin.
Short selling provides limited profit and unlimited risk.
Short selling can be done on any call and put formats like At the money, In the money and Out of money.
If you are expecting that the Nifty will come down in next coming days or weeks then short selling calls will provide profits.
Please note - Short selling will credit amount in your account while buying will debit amount from your account.
Example - suppose if Nifty Index is trading at 3250 and you are expecting that nifty will come down then you can short sell Nifty calls, following are few examples
a) Nifty call at 80 at strike price 3250, this is at the money call.
b) Nifty call at 50 at the strike price at 3200, this is in the money call.
c) Nifty call at 120 at the strike price 3300, this is out of money call.
The profits will starts coming as soon as the Nifty index starts moving in downward direction.
Short selling Puts
Put is bought when the underlying is expected to go down and the short selling of put is done when the underlying is expected to go up.
If you are expecting that the Nifty Index will come go up in next coming days or weeks then you can short sell Put.
Example - suppose if Nifty Index is trading at 3100 and you are expecting that nifty will go UP then you can short sell Nifty Puts, following are few examples
a) Nifty Put at 100 at the strike price 3100. This is at the money put
b) Nifty Put at 130 at the strike price 3200. This in the Money put.
c) Nifty Put at 110 at the strike price 300. This is Out of the money put.
The profits will starts coming as soon as the Nifty index starts moving in upward direction
There are various ways and methods to earn money from options.
Traders adopt their own ways which ever fulfills their requirements and needs.
a) Buying naked call or put
b) Short selling of calls and puts
c) Bullish Techniques - coming soon..
d) Bearish Techniques - coming soon..
a) Buying naked call or put
Naked calls and puts means traders do not hedge (or buy other side calls/puts to reduce the risk).
Hedging means buying other side calls and puts to reduce the risk if market turns against your trade.
Naked Call will be bought when the trader is expecting the underlying (either stock or Index) will go UP.
Naked Put will be bought when the trader is expecting the underlying (either stock or Index) will go DOWN
Buying Naked calls and puts provides unlimited profits and limited losses.
If trader uses hedging then further losses can also be reduced.
In the below example let’s see how trading is done on Naked calls and puts taking into consideration various trading scenarios
As a example - Let's say Nifty Index is currently trading at 3000 and a investor/trader purchases
One call option of Nifty Index at a price of Rs 50 whose strike price is at 3100 and expiry at 29 April 2009
So the total cost required to purchase one lot of Nifty call comes to Rs 2500 (Rs50 x 50 quantity)
This is also called as premium. This is your maximum loss you have to accept if the nifty falls down.
While the profits are unlimited as long as Nifty index keep going upside, especially once Nifty crosses 3100 which is your strike price.
Note - Each options contract represents one lot. Either you take it stock or Index.
So in our case one lot of Nifty Index consist of 50 quantities of Nifty.
Following are different scenarios will show how the Nifty Call Option will provide profits and losses.
First Scenario - If Nifty index rises to 3050.
Your profit is Rs 2500 ( Rs 50 x 50 qty) for one lot of Nifty Index.
Second Scenario - If Nifty index falls to 2950.
Your loss is Rs 2500 (Rs 50 x 50 Qty) for one lot of Nifty Index.
This is the maximum loss the trader has to pay.
Third Scenario - If Nifty Index falls below 2950 then no need to square off your call option.
No need to do anything, your option gets automatically expires at the end of the month and your maximum loss is RS 2500 which is your premium paid while buying the call.
Forth Scenario - Hedging your Call option
From above example you came to know that your maximum loss is Rs 2500 but if you want to reduce this loss, further, then you can hedge your call.
At the time of buying call you can buy one Nifty Put of strike price 2950.
So if Nifty starts falling below 3000, your call value starts decreasing while your Put value starts increasing
So over all when Nifty falls below 2950 your loss in call will be Rs 2500 (which is maximum) while you will get some profit in 2950 put. So your losses are reduced.
On the other hand if the nifty rises above 3050 then your put value decreases and your call value increases. So in this case your profit will be reduced.
b) Short selling of calls and puts
Short selling Calls
Call is bought when the underlying is expected to go up and the short selling of call is done when the underlying is expected to go down.
Short selling requires future derivative margin.
Short selling provides limited profit and unlimited risk.
Short selling can be done on any call and put formats like At the money, In the money and Out of money.
If you are expecting that the Nifty will come down in next coming days or weeks then short selling calls will provide profits.
Please note - Short selling will credit amount in your account while buying will debit amount from your account.
Example - suppose if Nifty Index is trading at 3250 and you are expecting that nifty will come down then you can short sell Nifty calls, following are few examples
a) Nifty call at 80 at strike price 3250, this is at the money call.
b) Nifty call at 50 at the strike price at 3200, this is in the money call.
c) Nifty call at 120 at the strike price 3300, this is out of money call.
The profits will starts coming as soon as the Nifty index starts moving in downward direction.
Short selling Puts
Put is bought when the underlying is expected to go down and the short selling of put is done when the underlying is expected to go up.
If you are expecting that the Nifty Index will come go up in next coming days or weeks then you can short sell Put.
Example - suppose if Nifty Index is trading at 3100 and you are expecting that nifty will go UP then you can short sell Nifty Puts, following are few examples
a) Nifty Put at 100 at the strike price 3100. This is at the money put
b) Nifty Put at 130 at the strike price 3200. This in the Money put.
c) Nifty Put at 110 at the strike price 300. This is Out of the money put.
The profits will starts coming as soon as the Nifty index starts moving in upward direction
