EQUITY DERIVATIVES OPTIONS
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Equity Derivatives Options
Stock options give a trader the right, but not the obligation, to buy or sell shares of a certain stock at an agreed-upon price and date, called the expiry date. A major volume of trading in the Indian stock market happens in the options segment, Because it has shares of stock (or a stock index) as its underlying asset, stock options are a form of equity derivative and may be called equity options.
When the specified date of expiry arrives, the contract expires, and its value becomes zero. Unlike futures, options do not obligate the buyer or seller to honour the contract. Options contracts are high-risk, high-reward
Types:
There are two types of options:
- Call options – It is a bet that a stock will rise,Call options afford the holder the right, but not the obligation, to buy the stock at a stated price within a specific timeframe.
- Put options – It is a bet that a stock will fall,Put options afford the holder the right, but not the obligation, to sell the stock at a stated price within a specific timeframe.
Basic terms in options:
- Spot Price – It refers to the current price of a security at which it can be bought/sold at a particular place and time.
- Strike price – The option is a contract that creates an agreement between two parties to have the option to sell or buy the stock at some point in the future at a specified price. The price is known as the Strike price. It is the price that a trader expects the stock to be above or below by the expiration date.
- Premium – In the options agreement, it’s the current price/ fee paid by the option buyer to the seller.The greater the volatility of the underlying asset,the greater the premium.
Benefits
- The returns on options trading would be much higher than buying shares on cash. As we are getting options on lower margin and getting the same profitability the percentage return would be much higher comparatively.
- An option buyer can only lose the value of the bought premium.
- When you buy options, it’s usually cheaper than buying actual stocks. You only pay a smaller amount called the premium and a trading fee. A trader or investor can get options position equal to a stock position at a much lower margin.
For example, in order to purchase 200 shares of a stock at price 80, an investor requires paying Rs. 16000. However, if he was to purchase call options of equal weightage, the premium required would be around Rs 4000. So we can have a fair idea of options cost efficiency. - Options allow you to benefit from stock price movements without having to buy actual shares. Consequently, your potential returns could be much higher compared to what you initially put in.
- With options, you can lock in a specific price for a certain period. This price is called the strike price. You can trade at that price anytime before the options contract expires.
- Options offer benefits like additional income, leverage, and protection. For example, you can use options as a hedge to protect against losses in the stock market.
- Many more Flexible investment strategy can be achieved trading options than with stocks.
Drawbacks:
- Options trades are usually shorter-term, which means you may trigger short-term capital gains. In India, investments held for less than a year are taxed as ordinary income, while long-term investments have a lower capital gains tax rate.
- Options sellers’ risk is potentially unlimited,The potential loss is therefore (in theory) infinite (although this can be mitigated by proper risk management).
- Lower liquidity of some stock options can be a major challenge for traders looking to enter and exit the trade market.
- Option trading is more expensive as compared to future or stock trading.