Part 3 Learn Institutional Trading

1. Introduction to Options Trading

Options trading is one of the most versatile and widely used financial instruments in modern financial markets. Unlike stocks, which represent ownership in a company, options are derivative contracts that give the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified period.

Options trading can be used for speculation, hedging, and income generation. Due to their unique characteristics, options are considered advanced financial instruments that require a solid understanding of market dynamics, risk management, and strategy planning.

2. Understanding the Basics of Options
2.1 What Are Options?

An option is a contract between two parties – the buyer and the seller (or writer). The contract is based on an underlying asset, which could be:

Stocks

Indices

Commodities

Currencies

ETFs (Exchange Traded Funds)

Options come in two main types:

Call Options – Give the holder the right to buy the underlying asset at a predetermined price (strike price) within a specified period.

Put Options – Give the holder the right to sell the underlying asset at the strike price within a specified period.

2.2 Key Terms in Options Trading

Understanding options terminology is crucial:

Strike Price (Exercise Price): The price at which the underlying asset can be bought or sold.

Expiration Date: The date on which the option contract expires.

Premium: The price paid by the buyer to purchase the option.

In-the-Money (ITM): An option has intrinsic value (e.g., a call option is ITM if the underlying asset price is above the strike price).

Out-of-the-Money (OTM): An option has no intrinsic value (e.g., a put option is OTM if the underlying asset price is above the strike price).

At-the-Money (ATM): The option’s strike price is equal or very close to the current price of the underlying asset.

Intrinsic Value: The difference between the current price of the underlying asset and the strike price.

Time Value: The portion of the option’s premium that reflects the potential for future profit before expiration.

2.3 How Options Work

Options provide leverage, meaning a small amount of capital can control a larger position in the underlying asset. For example, buying 100 shares of a stock may cost ₹1,00,000, whereas purchasing a call option for the same stock may cost only ₹10,000, offering a similar profit potential if the stock moves favorably.

The profit or loss depends on:

The difference between the strike price and the market price.

The premium paid for the option.

The time remaining until expiration.