To understand how the process of day trading options works, it is necessary to first gain an understanding of what options are.
Options are contracts that allow you to buy or sell a certain number of shares at a specific price. This is known as the strike price. You must also make the trade within a predetermined date, which is the expiration date.
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It is necessary to differentiate between the two types of options: call options and put options.
The stock that you buy or sell through an options contract is the underlying asset. The price at which you acquire it is the premium. This premium rises with the increment in value of the underlying asset.
Both the call and put options involve a buyer and a seller. The seller is also known as the writer.
Suppose you buy a call option at a premium of Rs 2 per share that gives you the right to buy 100 shares of ABC stock with a strike price of Rs 50 per share. Say, the current market price of the stock is Rs 48.50, and you have one month until the option expires. Now, imagine that the stock price rises to Rs 58 per share at some point within this month. Should you choose to, you can still buy the shares at Rs 50 per share, as specified by the call options contract.
As the price has increased by Rs 8 per share, you make a profit of Rs 800 (i.e. Rs 8 x 100 shares). But keep in mind that you bought the option at a premium of Rs 2 per share. This amounts to Rs 200 for 100 shares. So, your actual profit is Rs 600 (i.e. Rs 800 – Rs 200).
Now, consider the case of a put option. Your profit here depends on the depreciation in the value of the underlying asset. Say, you buy a put option for Rs 100 that allows you to sell 100 shares of a stock at Rs 40. You can make a profit only if the stock price falls to less than Rs 40.
As an options buyer, you are not obligated to buy or sell the security. But the writer of the options has to buy or sell the security at the strike price.
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A day trader has to complete the trade within a working day. If you are trading in options, you must keenly watch for movements in the stock price. This will allow you to buy or sell the assets at the optimum time. But what if you do not wish to buy or sell right away? You can still trade by selling the options. Time is of the essence here.
Options cost less than the actual stock price. This means you can invest in more stocks while risking less.
There is no liability when you buy or sell a security. In a losing situation, you lose only the premium.
Options contract prices may rise more than the stock prices they represent.
Options trading can be profitable when other financial instruments are failing.
The options market is less liquid. So, the bid-ask spread (i.e. the difference between the lowest price and the highest price) is often wider in case of options than stocks.
The price movement is restricted by the option premiums.
The loss of time can also decrease the gains.
Read more: What is a day trader
The first step is to choose a broker and opening a brokerage account. An online broker like Kotak can help you manage and capitalise on your trades. You can open a trading account for free. Then, focus on learning day trading strategies to start making profits.
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