We have seen a rapid growth in trading activities of option segment in Indian Derivatives market in the last couple of years. Daily turnover at National Stock Exchange (NSE) F&O segment is surpassing 4 lakh crore, out of which more than 80% is being contributed by index options. The same turnover surpasses Rs 10 lakh crore on Bank Nifty weekly and Nifty monthly expiry days. Option segment has become more popular nowadays, because of its own profile and that sounds exactly similar to the popularity of IPL T-20 matches as compared to 50 Overs or Test series matches. Trading activities are rapidly rising in this segment because it offers the opportunity to get the benefit of all kind of market sentiment whether it’s bullish, bearish, range bound or highly volatile. Let’s first understand, what is option all about? Apart from cash market where shares are bought or sold, exchanges have segments where futures and options of these stocks or indices can be bought or sold. In a nutshell, if you buy or sell a futures contract of any stock or index and if it keeps on going against your expected direction, that means your risk is unlimited. While if you buy an option contract in place of future contract, your risk is limited to the premium that you pay, while return is unlimited to the extent of favourable market movement. In a futures contract the risk is unlimited if market moves against you. For option buying, the risk is only limited to the premium paid similar to like how a person pays premium for taking insurance or mediclaim. Option buyers have to pay the premium so they get the right, but not the obligation. So risk is limited, irrespective of the fall in the market, while reward is unlimited if market moves higher. If a trader has a bullish view, he or she can trade in ‘call’ option while those with a bearish outlook can trade in ‘put’ option. ‘Call’ means right to buy and ‘Put’ means right to sell. Option sellers receive this premium so their risk is unlimited, but profit is limited to only premium price that they get for this option contract. If one takes 500 shares of Reliance, let's assume at Rs 1,000 in futures, then the risk is as per its decline. However, if they take a call option of Reliance 1,000 call and at Rs 20, then the risk is limited to only Rs 10,000 (20 × 500 lot size). Myth and Reality of options and options trading Options are too risky: Options are risky only if we don’t understand how to use them. Risk for buyer is only up to the premium amount. While the only high risk in option is when you are naked seller. So it requires a proper market judgement or hedging strategy which in fact reduces risk. That is the beauty of the option segment. Options are difficult to understand: Options by themselves are not difficult to understand. Basically, you have the right to buy or sell an underlying stock at a specified price. Even better, there are only two options - Call and Put, and you can either buy or sell. If you are a beginner, it’s best to stick with relatively simple strategies, like buying and selling ‘put’ and ‘call’ options. Selling options is like receiving free money: There is an incorrect belief that selling options is nearly risk free. Although selling options to collect cash looks safe, selling naked or uncovered options is a risky strategy because there is unlimited risk. Option sellers can win most of the time; the occasional losses can be devastating when inexperienced investors don’t manage risk properly with discipline. Only options sellers make money: The fact is that both option buyers and sellers can make profit from option trading. If only sellers make money then there would be no buyers, with no buyers there would be no market. Sometimes option buying does have an edge in many cases especially at the scenario of high volatility, trending or directional market. We have seen many times that premiums have gone to multi-fold. There is a general misconception that option trading is very risky. Options can be risky, but they don’t have to be. Options can be less risky or more risky, depending on risk tolerance. It can be used for speculation, but also for hedging, protection and leverage. PRACTISE DISCIPLINE WHILE TRADING Option buyers pay the premium so they get the right, but not the obligation. So risk is limited, even if the market falls, while reward is unlimited if market moves higher. Risk for buyer is only up to the premium amount. It requires proper market judgement or hedging strategy. Option sellers receive the premium so their risk is unlimited. But profit is limited to the premium price they get. Sometimes option buying does have an edge, especially in a scenario of high volatility, trending or directional market.
/ / Option trading only for investors who can tolerate risk