Introduction to Options Trading

It was a bright, sunshade afternoon, and Raghav, a young professional in Mumbai, sat sipping his coffee, scrolling through his phone. Of late, options trading became something he had been hearing about at work, amongst friends, and in the news. People around him seemed to be making money in this exciting world, and it was gaining his curiosity. What is options trading, and where could he get started?

"Let me check this out," Raghav thought, typing into Google, "What is options trading?

The Basics: What are Options?

Soon, Raghav came to know that options are financial contracts that give call buyers and all buyers the right but not the obligation to buy some stock or another type of underlying security. Sellers have an obligation to sell. Options come in two main types:

• Call Option: An option to buy the stock at a predetermined price.
  
• Put Option: This option gives the holder the right to sell the stock at a certain predetermined price.
  

Raghav thought, "So, I get the option to buy or sell a stock, but I am not obligated to. Interesting!

The Players in Options Trading

Raghav also found out that the two main parties in an option contract are the buyer and the seller, otherwise known as the writer.

• As the buyer, you pay a premium for the option; that is the price you pay for the right to trade the stock. Your maximum loss is limited to this premium, no matter how the market moves.
  
• As a seller, you collect the premium directly upfront, but you bear all the risks. In order to exercise the option, a seller needs to execute the contract.
  

Raghav wondered why anybody would sell an option. The answer, he found, was that a seller thought the option would expire worthless. If the buyer doesn't exercise the option, if the stock price doesn't reach the strike price, then the seller gets to keep the premium without any further obligation.

A Simple Example

For a better understanding, Raghav made a practical application of it: say Infosys is quoting ₹1,600, so he has entered a call option for buying having a strike price of ₹1,650.

• He can exercise the option if the stock rises to ₹1,750; he can buy at ₹1,650 and sell at ₹1,750.
  
• But if the stock stays below ₹1,650, he simply lets the option expire and loses only the premium paid.
  

This helps investors hedge against risks or speculate on the stock price movements without actually needing to hold the stock.

How Options Work

In India, the channel for options trading is on the National Stock Exchange (NSE). Options on underlying stocks like Reliance, HDFC, and TCS are generally traded. There are also index options whereby one can trade based on the overall performance of an index, such as the Nifty 50 Index.

Soon, Raghav realised that options trading could be complex. Factors like market volatility, Greeks, the metrics used to measure options' sensitivity to price changes and time decay could make the process dicey.

Conclusion

Raghav saw the potential. Options trading could be an exciting way to make money, but it requires knowledge and strategy. He decided to start small, perhaps with a paper trading account, before risking real money. The key for beginners would be to go slow, understand the risks, and invest more money at no time than one can afford to lose. Just like Raghav, anybody is free to enter into the world of options trading, but again, it doesn't hurt to learn and practice very, very carefully at the same time. After all, options trading is, like life itself, a matter of risk management and seizing the right opportunities.

The next thing Raghav knew, he had to plunge deep into understanding the core of options: Calls and Puts. These two basic building blocks are a must in the options world for any trader. What does it really mean to call or put? And how can such strategies help mitigate risks and maximise returns? We will explore these concepts further, as Raghav understood they'd be the foundation of his options journey.