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Category: Future & Options

  • Advanced Hedging Techniques with Futures and Options

    Advanced Hedging Techniques with Futures and Options

    In the dynamic landscape of financial markets, managing portfolio risk has become an essential aspect of investment strategy. Hedging, particularly through futures and options, provides investors with a structured approach to safeguarding capital against price fluctuations.

    The global growth in derivative trading underlines this trend. In 2023, futures and options contracts reached a record volume of 137 billion, with the Asia-Pacific region, and notably India, contributing significantly to this rise. This momentum reflects the increasing adoption of hedging instruments to navigate volatility and protect investment outcomes.

    This guide outlines advanced techniques to hedge positions using futures and options—designed to help market participants mitigate exposure, preserve capital, and optimize returns.

    What Is Hedging in Simple Terms?

    Hedging is a strategic process of offsetting potential losses in one position by taking an opposing position in a related asset. Much like an insurance policy, it aims to reduce the financial impact of adverse price movements without necessarily seeking to generate profits from the hedge itself.

    Why is Hedging Important?

    In an unpredictable market, even the most well-planned investments can face sudden fluctuations. Hedging acts as a protective strategy that helps investors manage risks and safeguard their portfolios from unforeseen losses. Here’s why hedging plays a vital role in sound financial planning:

    Protects Against Losses: Hedging helps limit potential losses caused by market volatility or sudden price changes.

    Ensures Stability: It keeps your portfolio value stable during uncertain times.

    Supports Long-Term Goals: Hedging allows investors to hold their positions for the long term without panic-selling.

    Improves Confidence: By reducing downside risk, investors can make calmer, more informed decisions.

    Acts as Insurance: Just like an insurance policy, it provides financial protection against unexpected market movements.

    How to Hedge with Futures Contracts

    Futures contracts are standardized agreements to buy or sell an asset at a predetermined price on a specified date. Their binding nature makes them a preferred choice for businesses and investors looking to stabilize costs or returns.

    If you’re starting your trading journey, you can open an online demat account with a trusted broker like Findoc to access futures and options markets seamlessly.

     

    1. Short Hedge (Selling Futures)

    A short hedge involves selling a futures contract to protect against a possible decline in the price of an asset that one intends to sell in the future.

    Use Case: A manufacturer expecting to sell copper in three months may enter a short futures position to lock in today’s prices and avoid losses from a potential market drop.

    2. Long Hedge (Buying Futures)

    A long hedge is implemented by buying futures contracts to secure the current price of an asset that is expected to be purchased later.

    Use Case: An airline company anticipating a fuel purchase might go long on crude oil futures to protect against rising prices.

    Examples: Let’s say you buy 500 shares of company A at ₹200 each, making your total investment ₹1,00,000. You are worried that the stock price may drop after the upcoming quarterly results. To protect yourself, you decide to hedge with futures by taking a short position.

    You sell one futures contract at ₹202 per share.

    • If the stock price falls to ₹180, you lose ₹20 per share in the cash market (₹10,000 total).

    • But you gain ₹22 per share in the futures market (₹11,000 total).
      Your net profit = ₹1,000, protecting your portfolio from major loss.

    Benefits of Hedging Through Futures

    • Capital Efficiency: Futures require only a margin deposit, allowing traders to control large positions with limited capital.
    • High Liquidity: Futures markets are highly liquid, ensuring rapid execution and minimal price slippage.
    • Price Certainty: Futures enable precise cost forecasting, especially in industries reliant on commodities.
    • Versatility: Suitable for hedging interest rate, currency, and commodity exposures.

    How to Hedge with Options Contracts

    Options provide the right, but not the obligation, to buy or sell an asset at a specific price before the expiration date. This flexibility allows for more tailored risk management strategies compared to futures.

    1. Call Options – Protecting Against Upside Risk

    Call options grant the right to buy an asset at a specified strike price. They are typically used when an investor anticipates a price increase but prefers to limit downside risk.

    Use Case: A fund manager might purchase a call option on the Nifty index to hedge against a potential market rally while preserving downside protection.

    2. Put Options – Shielding from Downside Risk

    Put options provide the right to sell an asset at a predetermined price. They are commonly used to protect long positions from potential losses.

    Use Case: An investor holding a portfolio of banking stocks may buy put options on a banking index to safeguard against sector-specific declines.

    Examples: Now, suppose you buy 1,000 shares of company B at ₹100 each, for a total of ₹1,00,000. To protect against possible decline, you purchase a put option at a premium of ₹5 per share with a strike price of ₹100.

    • If the stock price drops to ₹80, your cash market loss is ₹20,000.

    • But your put option gains ₹15 per share (₹15,000 total).
      Your total loss = only ₹5,000 (the premium paid).
       If the stock rises to ₹120, you ignore the option and keep your ₹20,000 gain, minus ₹5,000 premium — ending with a net profit of ₹15,000.

    Advantages of Options-Based Hedging

    • Defined Risk Exposure: Maximum loss is limited to the premium paid for the option.
    • Strategic Flexibility: Options allow for numerous strategies tailored to various market views and risk appetites.
    • Volatility Management: They are particularly useful in managing exposure to sharp price movements.
    • No Obligation: Unlike futures, options do not bind the holder to exercise the contract, offering flexibility in execution.

    Advanced Hedging Strategies in Futures and Options

    Once you’re comfortable with the basics, these techniques offer more control and precision.

    1. Spread Strategies

    Spread trading involves simultaneously buying and selling related contracts to capitalize on the price differential while limiting overall exposure.

    • Bull Call Spread: Buy a lower strike call and sell a higher strike call when anticipating moderate upside.
    • Bear Put Spread: Buy a higher strike put and sell a lower strike put when expecting moderate downside.

    2. Straddles and Strangles

    These volatility-based strategies involve taking positions on both call and put options.

    • Straddle: Purchase both a call and a put at the same strike price—ideal for uncertain directional moves.
    • Strangle: Buy a call and a put with different strike prices—more cost-effective in highly volatile environments.

    3. Delta Hedging

    This dynamic strategy involves adjusting a portfolio’s exposure to make it delta-neutral, thereby insulating it from small price movements.

    Example: If the delta of a portfolio is +0.5, selling underlying assets in proportion can help neutralize the position.

    Also read: Top Ten Option Trading Strategies for Smarter Trades to strengthen your understanding of how options can be used strategically in different market conditions.

    Difference Between Hedging with Futures vs. Options

    Feature Futures Options
    Obligation Yes No
    Upfront Cost Margin required Premium only
    Risk High (can be unlimited) Limited to premium
    Flexibility Low High

    Key Tips to Hedge Smarter

    In volatile markets, successful trading isn’t just about spotting opportunities—it’s also about protecting your capital. Hedging is a vital risk management tool, but like any strategy, it requires precision, timing, and regular fine-tuning. A smart hedge isn’t just about limiting losses—it’s about optimizing returns while keeping risk exposure in check.

    Whether you’re managing options, futures, or OTC derivatives, here are some key considerations that traders should keep in mind to implement hedging strategies more effectively and avoid common pitfalls:

    • Avoid Overhedging: Excessive hedging may erode profits rather than protect capital.
    • Monitor Liquidity: Always assess the liquidity of the instruments involved to avoid inefficiencies.
    • Account for Rolling Costs: When extending positions, factor in transaction and rollover costs.
    • Evaluate Counterparty Risk: Especially relevant for OTC derivatives.
    • Review Regularly: Hedging strategies should evolve based on market trends and portfolio adjustments.

    Risks with Hedging

    While hedging is an effective tool for managing risk, it is not without its challenges. Investors should understand the potential downsides before using hedging strategies, as improper execution can sometimes lead to higher costs or reduced returns. Here are some key risks to consider:

    • High Costs: Premiums and margin requirements can make hedging expensive.

    • Limited Profit Potential: While protecting against losses, hedging also caps potential profits.

    • Complex Strategies: Using futures and options requires market knowledge and continuous monitoring.

    • Market Timing Risk: Incorrect timing or misjudged hedge size can increase losses instead of reducing them.

    • Liquidity Risk: Some derivative contracts may not have enough buyers or sellers, making it harder to exit a trade quickly.

    Final Thoughts

    Hedging with futures and options isn’t about guessing market moves—it’s about protecting your money. When used well, these tools help you reduce risk, stabilize returns, and seize market opportunities even in turbulent times. Financial institutions and individual investors alike are increasingly leveraging these tools not only for protection but also for strategic positioning.

    Need a hedging strategy that works in real-world markets?

    Connect with Findoc to monitor live data, plan smart trades, and avoid costly errors. Take control of your portfolio today.

    Frequently Asked Questions

    Hedging is a strategy used to reduce financial risk by taking an opposite position in related assets, like futures or options, to offset possible losses.

    Investors use Futures and Options (F&O) to protect portfolios by buying or selling contracts that move opposite to their existing holdings.

    Option hedging limits losses but also restricts profits. It is more helpful in protecting investments than in making large gains.

    You can hedge a portfolio by taking a short position in Nifty futures if you expect the overall market to fall, thereby reducing portfolio risk.

  • Options Explained: Meaning, Types, Features, and How They Work?

    Options Explained: Meaning, Types, Features, and How They Work?

    Option trading is a flexible financial instrument that allows investors to buy or sell assets at a predetermined price on or before a specific date. In India, options have become popular in the derivatives market, providing ways for traders to hedge risk, speculate, or leverage investments. Let’s explore what options are, along with their features, types, and how they work.

    What are Options?

    Options are financial contracts that give buyers the right, but not the obligation, to buy or sell an underlying asset (like stocks) at a fixed price within a certain timeframe. There are two types of options; Call Options and Put Options. 

    Call Options let you buy an asset at a set price while Put Options let you sell an asset at a set price.

    Options can be based on various assets, such as stocks, indices, or commodities. For instance, traders in India often use options on popular stocks like Tata Steel for hedging or speculative purposes.

    Understanding Options With Example

     

    Let’s take a look at a real-time example of an Options contract on Tata Steel Company to understand it better:

    On October 31, 2024, the TATASTEEL 28-Nov-24 155 CE gained 4.5% in one day, closing at ₹8. Sounds interesting, right? But what does this actually mean?

    Let’s understand this option contract step by step:

    • The term “TATASTEEL 28-Nov-24 155 CE” represents an Options contract on the Tata Steel Ltd. stock as the underlying asset.
    • The date 28-Nov-24 shows the option expires on November 28, 2024. You can exercise it only on this date.
    • CE stands for a Call Option of the European type. This call option gives you the right to buy Tata Steel shares at the strike price on the expiration date.
    • The number 155 is the strike price, which means that you have the option to buy Tata Steel shares at ₹155 on November 28, 2024, no matter what the market price is on that date.

    To buy this option, you pay a premium. Let’s say on November 4, 2024, this premium is ₹10 per contract. This cost is much lower than buying the stock outright, allowing you to gain potential upside with limited upfront investment.

    In this case, if Tata Steel’s stock price rises above ₹155 by November 28, 2024, your option becomes valuable because you can buy it at ₹155, even if the market price is higher. This setup allows you to profit from price increases with a controlled cost

    Types of Options

    Option trading offers flexibility for both buyers and sellers, allowing them to profit from stock market movements without directly buying or selling the underlying asset. There are two primary types of options: Call Options and Put Options. Each serves a distinct purpose depending on the market outlook. Let’s explore these two main types of options in more detail.

    1. Call Option

    A Call Option gives you the right to buy a stock at a specific price, known as the strike price, within a set time period. It’s useful if you believe the stock’s price will rise.

    For example, Reliance Industries stock is trading at ₹2,500 per share. You believe it will rise, so you buy a Call Option with a ₹2,600 strike price that expires in one month. This option gives you the right to buy Reliance shares at ₹2,600, regardless of the market price.

    If Reliance’s price increases to ₹2,700, you can exercise the option, buy the shares at ₹2,600, and then sell them at the market price of ₹2,700, thereby booking a profit. However, if the price doesn’t reach ₹2,600, you don’t have to exercise the option, and your only loss is the premium you paid for the option.

    2. Put Option

    A Put Option gives you the right to sell a stock at a specific price, known as the strike price, within a set time period. This is helpful if you believe the stock’s price will decline.

    For example, Infosys stock is trading at ₹1,400 per share. You expect it to drop, so you buy a Put Option with a ₹1,350 strike price, expiring in one month. This option lets you sell Infosys shares at ₹1,350, regardless of the market price.

    If Infosys’s price falls to ₹1,300, you can exercise the option, sell the shares at ₹1,350, and book a profit. However, if the price stays above ₹1,350, you don’t have to exercise the option, and your only cost is the premium you paid for the option.

    Options are also classified based on when they can be exercised:

    • American Options: Can be exercised anytime before expiration.
    • European Options: Can only be exercised at expiration.

    In India, index options are European-style, while stock options are American-style, offering different strategic advantages to traders.

    Features of an Options Contract

    Options contracts have unique features that make them flexible trading instruments:

    • Strike Price: The price at which the underlying asset can be bought or sold.
    • Premium: The cost of buying an option contract. This premium fluctuates based on the underlying asset’s price, time to expiration, and market volatility.
    • Expiration Date: The date the option expires, beyond which it becomes invalid.
    • Lot Size: The number of units in each option contract, standardized on stock exchanges.

    American Options vs. European Options

    American options and European options are two common types of options contracts that primarily differ in when the option holder can exercise their rights.

    American Options allow the holder to exercise the option at any time before the expiration date. This flexibility can be advantageous when market conditions change rapidly, allowing for potential profits to be realized sooner.

    European Options, on the other hand, can only be exercised on the expiration date itself. This more restrictive approach can be beneficial in specific market scenarios, such as when there’s a high probability of the underlying asset’s price moving in the desired direction near the expiration date

    How Do Options Work?

    Options allow traders to speculate on asset price movements with limited risk. When you buy a Call Option, you’re betting that the asset’s price will rise above the strike price before expiration. If it does, you can buy the asset at the lower strike price and sell it at the higher market price, booking a profit. Conversely, if you buy a Put Option, you profit if the asset’s price falls below the strike price.

    Traders often use various option trading strategies to maximize their potential gains or minimize losses. For instance, combining Call and Put options can create protective strategies that align with market conditions.

    Options offer leverage, meaning you only pay a premium instead of the full price of the asset. However, they also expire, so timing is crucial.

    How To Use Options in Trading?

    Traders use options for several purposes:

    • Hedging: Investors use options as a hedging strategy to protect their holdings from market volatility.
    • Speculation: Traders can profit from price changes without owning the underlying asset.
    • Income Generation: Some investors sell options to earn premiums, a strategy known as covered call writing.

    For instance, if you hold RIL shares but are concerned about short-term volatility, buying a Put Option can offset potential losses if the stock price drops.

    Understanding Options Pricing

    Options pricing depends on multiple factors, mainly:

    • Intrinsic Value: The difference between the asset’s current price and the strike price.
    • Time Value: The additional value due to the time left until expiration.
    • Volatility: Higher volatility means higher premiums, as the potential for profit (and risk) increases.

    For example, a Call Option on RIL with a strike price close to the market price and high volatility will have a higher premium.

    Advantages of Option Trading

    1. Limited Loss: Buyers’ losses are limited to the premium paid, even if the market moves against them.
    2. Leverage: Options allow control over a large amount of assets with a smaller initial investment.
    3. Flexibility: Traders can profit from different market conditions, whether they expect prices to rise, fall, or remain stable.

    Disadvantages of Options

    1. Time Decay: Options lose value as expiration approaches, potentially leading to a loss if the asset doesn’t move as expected.
    2. Complexity: Options involve multiple factors in pricing, making them more complex than direct stock investments.
    3. Risk for Sellers: While buyers’ losses are capped, sellers can face unlimited losses if the market moves significantly against their position.

    Conclusion

    Option trading offers investors a unique way to manage risk and capitalize on market movements. By understanding the types of options, their features, expiration dates, and premiums, traders can make informed decisions. While options offer the potential for significant profits, they also come with risks, including the loss of the premium paid. Therefore, it is essential to approach option trading with a clear strategy and a thorough understanding of the underlying asset. With careful planning and market analysis, options can be a valuable tool in an investor’s trading toolkit.

    FAQs

    Options provide a way to hedge risk, speculate on price changes, and leverage capital without directly buying or selling the asset.

    No, options are only available on selected stocks like Nifty 50 and indices in the Indian market, as approved by the stock exchanges.

    The premium is the price paid to buy an option contract, determined by factors like strike price, time to expiration, and market volatility.

    Yes, if the underlying asset’s price does not reach a profitable level, the option will expire worthless, and the buyer loses only premium.

    Options require a solid understanding of stock market movements, so it’s best for beginners to learn thoroughly or consult with stock brokerage firms like Findoc before trading in options.

  • Mistakes Traders Commit While Trading Futures Options

    Mistakes Traders Commit While Trading Futures Options

    Making mistakes is an inherent part of the learning process in both trading and investing. While investors typically focus on holding assets like stocks, exchange-traded funds (ETFs), and other securities for longer periods, traders often engage in buying and selling futures and options, holding these positions for shorter durations with more frequent transactions.

    In Indian Stock Market, many traders engage in derivatives like futures and options, often holding positions for a brief time. However, the fast-paced nature of derivative trading can lead to common pitfalls, especially for those who are less experienced.

    Here are some of the key mistakes traders often commit when trading in derivatives:

    1. Lack of a Trading Plan

    A well-defined trading plan is essential for anyone engaging in trading futures options. This plan should clearly outline the goals, objectives, entry, and exit strategies for each trade. Seasoned traders understand the importance of adhering strictly to their plan, while beginners might either lack a solid plan or deviate from it under market pressure. Without a plan, traders are more susceptible to making impulsive decisions, which can lead to significant losses.

    2. Ignoring Risk Management

    Risk management is crucial in trading. Every trader should assess their risk tolerance before entering the market. Some investors can handle high market volatility, while others cannot. Failing to recognize and manage risk can result in excessive losses. Traders must understand when to exit the market to avoid bearing unnecessary and abnormal losses.

    3. Not Using Stop-Loss Orders

    One of the most critical components of a trading plan is the use of stop-loss orders. A stop-loss order is a predefined level at which a trader is willing to exit a losing position to prevent further losses. The absence of a stop-loss strategy is a clear indicator of a lack of a trading plan. By using tight stop-loss orders, traders can minimize their losses before they escalate. This not only helps in risk management but also preserves the trader’s capital, enabling them to continue trading.

    4. Overtrading

    Overtrading occurs when traders execute too many trades in a short period, often driven by the fear of missing out (FOMO) or the urge to recover losses quickly. This behavior can lead to increased transaction costs, emotional fatigue, and ultimately, poor decision-making. Traders should focus on quality over quantity, ensuring that each trade aligns with their overall strategy.

    5. Lack of Market Knowledge

    Understanding the market conditions and the instruments being traded is vital. Many traders jump into derivative trading without sufficient knowledge of how futures and options work or the factors influencing their prices. This lack of understanding can lead to misjudgments and costly mistakes. Continuous learning and staying updated with market trends are essential to avoid this pitfall.

    Conclusion

    By being mindful of these common mistakes—such as not having a trading plan, ignoring risk management, neglecting to use stop-loss orders, overtrading, and lacking market knowledge—traders can significantly improve their chances of success in futures and options, also known as derivative trading. Staying informed through derivative news and adopting a disciplined approach, combined with continuous education and experience, will help traders develop a successful and sustainable trading strategy.

  • 10 Popular Option Trading Strategies For Smarter Trades

    10 Popular Option Trading Strategies For Smarter Trades

    Option trading helps traders manage risks and boost profits by giving them the right to buy or sell stocks at a fixed price within a set time. While it may seem tricky at first, using the right strategies makes it easier to handle market changes. With proper planning and focus, traders can reduce risks and make better decisions.
     
    Here are 10 popular stock option trading strategies that explain how to use them effectively and what risks and rewards they offer.

    1. Long Straddle Option Strategy

    A Long Straddle option strategy involves purchasing both a call and put option on the same underlying asset with the same strike price and expiration date. This strategy is ideal when a trader expects significant movement in the asset price but is not sure which direction the move will take.

    For example, suppose a stock is trading at ₹100. The trader buys both a ₹100 call and a ₹100 put. If the stock moves to ₹130 (bullish scenario) or ₹70 (bearish scenario), the trader can profit, as the gains from one option will outweigh the loss from the other.

    2. Long Strangle Option Strategy

    A Long Strangle option strategy involves purchasing an out-of-the-money call and put option on the same underlying asset. This strategy is used when a trader expects a large move in the asset but is uncertain about the direction (highlight uncertainty for “bullish or bearish” moves).

    For example, if a stock is at ₹100, the trader buys a ₹110 call and an ₹90 put. The price must move significantly (either above ₹110 or below ₹90) for the strategy to be profitable.

    3. Long Call Butterfly Option Strategy

    Long Call Butterfly option strategy combines a bull spread and a bear spread. The trader buys one in-the-money call, sells two at-the-money calls, and buys one out-of-the-money call. This setup benefits from minimal movement in the asset price (neutral or sideways markets).

    For example, if a stock is at ₹100, the trader might buy a ₹90 call, sell two ₹100 calls, and buy a ₹110 call. The trader profits if the stock stays around ₹100 at expiration.

    4. Iron Butterfly Option Strategy

    The Iron Butterfly option strategy involves selling an at-the-money call and put while simultaneously buying out-of-the-money call and put options on the same asset. The strategy benefits from low volatility or a neutral market.

    For example, a stock trading at ₹100 sees the trader sell a ₹100 call and put, while buying a ₹110 call and ₹90 put. The maximum profit occurs if the stock stays at ₹100.

    5. Iron Condor Option Strategy

    An Iron Condor option strategy combines a bull put spread and a bear call spread. The trader sells an out-of-the-money put and buys a lower-strike put while selling an out-of-the-money call and buying a higher-strike call.

    For example, for a stock at ₹100, the trader might sell a ₹90 put, buy a ₹80 put, sell a ₹110 call, and buy a ₹120 call. This strategy profits when the asset stays between ₹90 and ₹110.

    6. Bull Call Spread Option Strategy

    The Bull Call Spread option strategy involves buying a call option at one strike price and selling another call option at a higher strike price. This strategy works well in bullish markets with moderate upward movement.

    For example, a stock is at ₹100. The trader buys a ₹100 call and sells a ₹120 call. If the stock rises to ₹115, the trader makes a profit, but the upside is capped at ₹120.

    7. Bear Put Spread Option Strategy

    A Bear Put Spread option strategy is a vertical spread where a trader buys a put option at one strike price and sells a put option at a lower strike price. This strategy is ideal for bearish markets where the trader expects the asset price to fall.

    For example, if a stock is at ₹100, the trader buys a ₹100 put and sells a ₹90 put. If the stock drops to ₹90, the trader profits from the spread between the strike prices.

    8. Calendar Spread Option Strategy

    A Calendar Spread option strategy involves buying and selling options with different expiration dates but the same strike price. It can benefit from changes in volatility but works best in markets with neutral or slightly bullish/bearish trends.

    For example, a trader buys a long-term option with a one-month expiration and sells a short-term option with a one-week expiration on the same asset.

    9. Synthetic Call Option Strategy

    A Synthetic Call option strategy replicates the payoff of a call option using a stock and a put option. It is suited for bullish scenarios with growth potential.

    For example, the trader buys a ₹100 stock and sells a ₹100 put. If the stock price rises, the trader profits like they would from a call option.

    10. Synthetic Put Option Strategy

    A Synthetic Put option strategy works like a put option by combining a short stock position with a long call option. It is used to hedge risk in bearish markets.

    For example, a trader who is short on a stock might buy a call option to protect against potential price increases.

    Bonus Strategy: Covered Call Option Strategy

    A Covered Call option strategy involves buying a stock and simultaneously selling a call option on the same stock. This strategy generates income and reduces some risk associated with holding the stock, especially in bullish to neutral markets.

    For example, a trader buys 100 shares of a stock at ₹50 each and sells a call option with a strike price of ₹60. If the stock remains below ₹60, the trader collects the premium from the call option.

    Risk and Reward in Option Trading Strategies

    The table below offers a quick overview for traders to assess the relative risks and rewards of these option trading strategies and choose the one that aligns with their market outlook.

    Strategy Risk Reward Best For
    Long Straddle Limited to premium paid Unlimited Highly volatile markets
    Long Strangle Limited to premium paid Unlimited Highly volatile markets
    Long Call Butterfly Limited to premium paid Limited to the width of the strikes Markets with minimal movement
    Iron Butterfly Limited to the premium paid Limited Stable markets
    Iron Condor Limited to the difference between strike prices minus premiums Limited Low volatility markets
    Bull Call Spread Limited to the premium paid Limited to the difference between strike prices Moderate upward movement
    Bear Put Spread Limited to the premium paid Limited to the difference between strike prices Moderate downward movement
    Calendar Spread Limited to the cost of the long-term option Limited Markets with stable trends and expected volatility changes
    Synthetic Call Limited to the cost of the stock minus the premium received Unlimited Markets with expected upward movement
    Synthetic Put Limited to the cost of the call option Limited protection for short positions Markets with expected downward movement
    Covered Call Downside of the stock Limited to the strike price plus premium received Generating income from holding stocks

    Common Mistakes to Avoid in Option Trading

    1. Not Accounting for Time Decay

    Options lose value as they approach expiration, particularly out-of-the-money options. Ignoring this can result in unexpected losses, even if the underlying asset moves in your favor.

    2. Over-Leveraging Positions

    Using too much margin can amplify both profits and losses. It is important to manage leverage carefully to avoid risking more than you can afford.

    3. Not Adjusting Positions

    If the market moves against you, it is crucial to adjust or close your positions. Failing to do so could lead to larger losses as the situation evolves.

    Which Option Strategy Is Right for You?

    Do you expect the market to be volatile?

    • Yes → Consider Long Straddle or Long Strangle.
    • No → Consider Iron Condor or Covered Call.

    Conclusion

    Option trading can be a powerful tool for beginners and experienced traders alike, but it is important to use the right strategies based on market conditions. Whether navigating volatile markets with strategies like Long Straddle or generating income with a Covered Call, understanding risk and reward balance in each strategy can help traders optimize their decisions.

    By practicing these stock option trading strategies and learning how to manage risks, beginners can build confidence and become more successful in their trading journeys.

    Ready to take your trading to the next level? Open a free Demat account with Findoc today and start trading options!

  • Introduction to Options Trading: A Beginners Guide

    Introduction to Options Trading: A Beginners Guide

    Everyone like to have options so that they can choose as per their wish. This is what options trading gives you, the option to choose. In the stock market, or to be specific derivatives market, options are like the ruler, with all the power and no obligations.

    However, for beginners, option trading may seem a bit complex, as there are a lot of things to keep in mind while trading options. That said, options are also one of the best ways to trade in the market without putting in a lot of money, however, that doesn’t restrict your profit potential. Let us find out how and to do that, we need to dig deeper.

    What are the Options and Option Trading?

    Options are derivative contracts, which are used to speculate the price of the underlying asset and trade accordingly. These derivative contracts offer the buyer the right to buy or sell the underlying asset at a specified date for a pre-determined price. While you get the right to buy or sell the underlying asset, there is no obligation to do it. This is the feature that makes options most sought after.

    So, Options trading can be defined as the trading process of buying and selling these option contracts.

    Types of Options

    Call option: Call option offers the ‘right to buy’ the underlying asset at a predetermined price on a specified date, without any obligation. Traders purchase the call option when they think the price of the underlying asset may go up in the future. So, in order to make a profit, they buy call options by paying a premium, which gives them the right to buy the underlying asset at a future date for a pre-determined price.

    Suppose, you think the price of stock A will go up next month as the company is coming up with new products, which have huge demand in the market. Let’s say, the current price of stock A is Rs. 1000. You are anticipating the price of the stock to go up to Rs. 1200 next month. Therefore, you buy the call option at a strike price of Rs. 1050. You bought five lots, and each lot has 100 stocks, and the premium you paid is Rs. 2000 each, which means a total of Rs. 10000, paid as a premium.

    Now there can be two scenario:

    Scenario 1: Price of stock A goes up to Rs. 1250 next month

    If this happens, then you can execute your call options, and buy 500 units of stock A at a price of Rs. 1050.

    Buying price = Rs. 1050*500 = Rs. 525000

    Premium paid earlier = Rs. 10000

    Total investment = Rs. 535000

    You can sell the shares at a price of Rs. 1250 each.

    Selling price = Rs. 1250*500 = Rs. 625000

    Net profit = Total Investment – selling price

    = Rs. 625000 -535000

    = Rs. 90000

    Scenario 2: Price of stock A decreases to Rs. 950 next month

    Now, since, the price drops against the expectation, you choose not to execute the contract. As there is no obligation to execute the contract on the contract buyer.

    Thus, your total loss would be the amount of premium paid in this case which is Rs. 10000.

    However, if you had invested in the stock instead of buying the call option, then

    • First, you had to invest Rs. 525000 at one go for buying 500 shares at Rs. 1050 each.
    • Secondly, if the price drops to Rs. 950 each, then your loss would have been Rs. 100 per share. Therefore the total loss would have been Rs. 100*500 = Rs. 50000.

    So, instead of losing Rs. 50000, you lost Rs. 10000, which is much better, isn’t it?

    Put Option: When you believe or anticipate the price of an asset to go down, you can buy a put option as this derivative contract gives you the right to sell an underlying asset at a predetermined price on a specified date, without any obligations of executing the contract.

    Again let’s understand this with an example;

    Suppose, you think the price of stock B will decrease in September 2023, as the company is not performing well in this quarter. So, purchase five Put options, by paying a premium of Rs. 2000 each, which makes it Rs. 10000 in total. The lot size of each put option is 100 shares. Thus, you can sell 500 shares at the end of the contract. Now, the current market price of stock B is Rs. 1000, and you think it will come down below Rs. 900 each by September. Therefore, the put options you bought have a strike price of Rs. 1000 for each share.

    Here, like above, can be two scenarios;

    Scenario 1: The price of stock B goes down to Rs. 850

    Since the price of the stock has come down as per your anticipation, you will execute your contract.

    To buy 500 shares, your investments would be Rs. 850*500 = Rs. 425000

    Selling price = Rs. 1000*500 = Rs. 500000

    Gross profit = Rs. 500000 -425000 = Rs. 75000

    Premium paid = Rs. 10000

    Net profit = Rs. 65000

    Scenario 2: Price of stock B goes up to Rs. 1100

    In this case, you can choose not to execute the contract and your loss would be limited to Rs. 10000 which is the premium amount paid by you.

    Suppose, you had short-sell 500 units of stock B at Rs. 1000, you had made Rs. 500000 then. However, if the price went up to Rs. 1100, for squaring off your position, you had to buy stock B at Rs. 1100 each, which means, an outlay of Rs. 550000. Therefore, in this case, your loss would have been Rs. 50000.

    The Extent of Profit and Loss

    • In the case of a call option, the maximum profit can be infinite for the call option buyer. This is because the price of the underlying asset can go up to any extent, and thus, there is no upper limit on the profit.
    • In the case of a put option, the maximum profit for the option buyer is the difference between the strike price of the contract and Rs. 0 as the price of the underlying asset cannot go below that.
    • The losses in both cases can be up to the amount of premium paid.

    Important Concepts of Option Trading

    In option trading, there are certain terminologies and concepts which you need to keep in mind. These include –

    • Strike Price: This is the price, which is determined at the time of drawing the option contract at which the buyer of the option contract will be able to buy or sell the underlying asset. As per the example for a put option, the strike price is Rs. 1000 which means the put option buyer, can sell the underlying asset which is stock B in that example at a price of Rs. 1000 when the market price has dropped to Rs. 850.
    • Expiration date: The contract will become executable on this date. It is also the expiration date and this is specified at the time of making the contract. Suppose, in the above example, the expiration date is 9th September, then on 9th September, if the price is below the strike price, and the option buyer is willing to execute the contract, he or she can. However, if not, then it will expire.
    • Premium: The premium is the amount you pay in order to purchase the option. In the above example, Rs. 5000 is the total premium paid for buying the five lots of put option. The premium is determined on the basis of the price of the underlying asset and values.
    • Intrinsic Value: in options trading, intrinsic value means the gap between the strike price of the option contract and the present market price of the underlying security. So, in the above example of a call option, the gap between the strike price and the current market price is Rs. 50 which is the intrinsic value.
    • Extrinsic value: This value is a qualitative measure of representing factors like is the premium amount for the contract is justifiable or not, how long the option will be good, and other such factors, which are not considered by the intrinsic value.
    • In-the-money option: If an option contract is profitable depending on the price of the underlying security and the time until expiration, then it is known as an in-the-money option. In the above, example, the time of expiration is in September. The strike price is Rs. 1000 and the underlying security’s price was Rs. 1000 at the beginning of the contract. So, the option will be in-the-money until the market price of the underlying security doesn’t go above the Rs. 1000 mark. Since, it is a put option, where you will make a profit when and if the price of the underlying security goes down. Therefore, it will be in-the-money until the price of the underlying security doesn’t go above the strike price.
    • Out-of-the-money Option: This is when the option contract becomes unprofitable. Going by the above put option example again, if the price of the underlying security goes above the strike price of Rs. 1000, then it will become an out-of-the-money option, as the price went up against your anticipation of price going down.

    How to Start Options Trading?

    If you are starting with options trading, then here are the steps you need to follow.

    • Firstly, you need to have an online trading account, which you can easily open with our quick and easy, paperless account opening process.
    • Now the next step is crucial, where you start finding those securities, which have the potential upside and downside. Once you find the same, you need to anticipate whether the price will go up or down in the future. If you think it will go up, you have to buy the call option and if you think it will go down you will have to purchase put options.
    • Then you need to determine the strike price of the option contract and also analyse if the premium that you have to pay is reasonable or not.
    • Next, you need to determine the period for the potential rise or decrease in the price. This is required for deciding the expiration date of the contract.
    • Once all these are sorted, you pay the premium and buy the options.
    • Now, upon expiration, if the options are in-the-money, then you can execute them and make a profit, while if they become out-of-the-money, then you can choose not to execute them.

    So, this is how you start options trading in the beginning and once you grow, you can learn new option trading strategies to generate better results.

    Option Trading Strategies for Beginners

    As a beginner in the option-trading arena, you can use the following three option-trading strategies to your benefit.

    Long call: This is one of the basic options trading strategies that beginners can use while trading options. Here you have to buy call options when you think the price of the underlying security will increase in the near term. Since you have to buy the call option, it is known as the ‘going long’ on-call option and thus, long call. In this strategy, there is no cap on the profit, while the loss is limited to the amount of premium paid.

    Long Put: When you expect the price of the underlying security to do down in the near future, you can buy put options, which is known as long put as you are ‘going long’ on the put option.

    Covered call: This options trading strategy is a little advanced where you have to sell a call option which means you are ‘going short’ as you expect the price of the underlying security to reduce but to protect yourself from the losses, you also buy underlying security equivalent to the number of units in the call option sold by you. You receive the call option premium as you sell the option in this strategy.

    Now if the price of the underlying security decreases below the strike price, as expected by you, then the call option buyer will not execute the contract, so, you do not have to sell the underlying securities and your profit is the premium you have received. On the contrary, if the price of the underlying security goes up against your expectation, then you sell the securities you have bought to the call option buyer at the strike price and the premium is retained by you, which is your profit.

    Why You Should Consider Options Trading?

    • Infinite returns: The maximum profit that one can make with options, especially the call option has no upper limit. It can go up to any extent as the price of the underlying security can increase in that way. Even in the put option, one can make a profit to the extent of the price of the underlying touching the floor.
    • Low Cost High Return: While the return potential is superb with options trading, the cost of trading these instruments is limited to the premium amount. This helps traders to generate higher returns without investing a lot of money.
    • Lower Risk Potential: The risk potential of the options is limited to the amount of premium paid.
    • Multiple strategies: There is a wide range of option trading strategies, which the traders can pick to enhance their trading and generate positive returns.

    Conclusion

    While buying or selling securities directly can help you make good returns, the downside is too risky as well and thus, trading options become more sensible to mitigate the risk to quite an extent while increasing the profit potential. However, you need to be cautious and evaluate everything before you start trading options.