Stock Market Basics

What is options trading and how to trade in call put options

If you want to trade with leverage, but want to limit your risk, options trading offers an excellent opportunity to do so. However, options are slightly complex in nature and a thorough understanding is needed before venturing into it.

Though there are numerous option strategies that are used by the experts, we shall explain the basics of options in this article. On completion of this article, you will have an understanding of both options selling and options buying.

Definition of an option

The Investopedia defines the option as a financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date).

With its technical terminologies options seem to be complex, but once you understand it, it is not very difficult.Let us simplify options further by using an example of nifty options.


Nifty 7700 strike price, CE(Call) quotes at 100 and PE(Put) quotes at 80, underlying nifty is at 7730



If you are bullish on the nifty and you believe that the nifty will be higher than a particular level by expiry time, you should buy calls to profit from it.


On the other hand, if you are bearish on the nifty and believe that the nifty will be lower than a particular level by expiry date, you should buy puts to profit from the fall.

Strike Price

This is the level at which the option is exercised. From our example, we have chosen the strike price of 7700 level on the nifty. That means, if nifty closes above 7700 by expiry, the calls will be in profit, depending on the amount of premium paid to buy the option.


On the other hand, if the expiry of the nifty is below the 7700 levels, all the 7700 calls will expire worthless, i.e., the call option buyers of 7700 strike levels will lose the amount paid as premium to own the call.


For the buyers of 7700 puts, if the expiry is below 7700 levels, the put buyers will earn profits depending on the amount of premium they have paid to buy the option. On the other hand, if the nifty expiry is above 7700 levels, the put buyers will lose their money.


Lot size

The stock exchanges determine the lot size of the stocks and the index. The lot sizes are fixed such that the total value of an option is Rs. 5,00,000.00. Therefore, the nifty lot size is currently fixed at 75 units.



The underlying is the stock or the index on which the derivatives is being traded. On the expiry day, the closing price of the underlying is used to determine whether the options close in profit or loss.


Option premium

The amount the option writer demands from the buyer,for the risk he takes in selling the option. If the market is bullish, the call writers will ask a higher premium because their risk is high. Similarly, in bearish markets, the put writers seek higher premium. During range-bound markets, the premium drops, as the risk to the option writers is low.


Option buyer

An option buyer pays a certain premium to buy the call or the put and profit from his analysis if the market moves in his expected direction. However, if the market doesn’t behave according to his expectations, he stands to lose the amount he paid as premium to buy the option.


Hence, the risk is limited to the amount of money paid to buy the option, but the profit potential is huge if the markets rise or drop vertically.


Option writer

An option writer is a trader who sells the option, hoping to pocket the premium amount paid by the option buyer by expiry. The option writer’s maximum profit potential is fixed at the amount he receives from the buyer, however, the risk is unlimited if the markets move against him vertically.


In the Indian stock markets, the last Thursday of every month is fixed as the expiry day. If Thursday is a holiday, then the previous trading day is fixed as the expiry day. The settlement of options is calculated based on the closing price of the index and stocks on the expiry day.

Exercising of options

If the buyer of the option wants to close his option before the expiry day, he can ask the exchange to exercise his option. The exchange will close the contract by paying the profit to the buyer.

European and American expiration

The index options are all European expiries, where the options are exercised only on the expiry day. Another type of expiry is the American expiry, which is used for stocks. The buyer can exercise the option on any trading day, if the closing value of the underlying is greater than the strike price of the option.

Option buyer

Most retail traders are option buyers because of the ease of buying, limited risk and theoretically unlimited profit potential.

Advantages of buying options

  1. Defined risk, unlike futures, where the risk can be high if the markets react adversely to any news overnight.
  2. Profit potential in options is high, similar to futures.
  3. Advantage of high leverage.
  4. Buyers can form various strategies depending on the strength of the market.

Disadvantages of buying options

  1. Most options expire worthless. Even though the risk is limited, losing regularly can quickly add to the losses.
  2. The buyer not only has to get the direction of the market right, he should get the timing also right, as the option premium loses value as the expiry day nears.
  3. Barring the nifty and a few large stocks, most other stock options are illiquid. The spread between the bid and ask price is high, making it difficult to buy and sell the option at a profit.
  4. Only near month options are active on stocks, hence, the time available for the stock to move is very less because of which the options expire worthless.

Option writers

Most of the large institutional players are option sellers. They use complex strategies to limit their risk and aim to pocket the amount they receive as a premium.

Advantages of option writing

  1. As only near-month options are active in India, most options expire worthless and the writers pocket the premium amount every month as profits.
  2. Most investors holding bluechip stocks write options against their holding and earn a steady income from it.

Disadvantages of option writing

  1. Selling a call or a put without proper risk management can lead to huge losses. There are many examples of options writers losing millions due to market crashes.
  2. The profit potential is fixed at the amount of money received as premium while selling the option.

Example of anifty put option trade

The markets are bearish and you believe that the nifty will fall from the current levels of 7730 to 7500 by the month end. Due to your bearish view, you decide to buy one lot (75 units) of 7700 puts quoting at Rs.80.00. The total amount required to complete this transaction is

7700PE= 80(premium of the option) x 75(lot size) = Rs. 6,000.00.

When you buy this option, your risk is fixed at Rs. 6,000.00, irrespective of how high the nifty rises. Now let’sdetermine the profit you will earn at different levels below 7700.

If nifty closes at 7700, your loss is Rs. 6,000.00

If nifty closes at any level higher than 7700, then also your loss is fixed at Rs. 6,000.00.

If nifty closes at 7600.

The total profit is 7700 (Strike price) – 7600 (expiry level) = 100 points profit.

We will receive 100x75=Rs. 7,500, from the option seller, however, as we had paid Rs. 6000 as premium to buy the option, our net profit is calculated on the investment we did while buying the option. Hence, on an investment of Rs. 6,000, we earn Rs. 1,500 net profit.

{100 (profit) x 75(lot size)} – (Premium paid) = Net profit

(100 x 75) - (6000) = 1,500.

Similarly, if expiry happens at 7500, our profit will be

7700 (Strike price) – 7500 (expiry level) = 200 points profit.

Net profit for one lot is = (200 x 75) - (6000) = 9,000.

Example of a nifty call option trade

If you believe that the markets are bullish and are likely to rise further and close higher than the current levels of 7730, you can buy 7700 strike price call options quoting at 100 rupees, by paying Rs. 7,500.00.

If Nifty closes at 7700 or below on expiry day, you will lose all your money.

However, if Nifty closes at 7800.

7800 (expiry level) - 7700 (Strike price) = 100 points profit.

{100 (profit) x 75(lot size)} – (Premium paid) = Net profit

(100 x 75) - (7500) = 0.

If Nifty closes at 7900;

7900 (expiry level) - 7700 (Strike price) = 200 points profit.

{200 (profit) x 75(lot size)} – (Premium paid) = Net profit

(100 x 75) - (7500) = 7500.


Options trading can be a very satisfying and profitable venture, if you spend enough time studying it. Options provide you with the high leverage of futures with minimum risk.

  1. If you are bullish, buy calls; if you are bearish, buy puts. If you believe that the markets will remain range-bound, you will have to use various other strategies.
  2. Option writers are usually large institutional traders and investors, whereas, option buyers are retail traders.
  3. Venture into options trading only if you have perfected the art of short-term trading. As only the near-month options are activein India, you should be able to get both the direction and the timing right if you want to be a profitable options trader.
  4. Many stock options are illiquid. There is a large spread between the bid and the ask, avoid trading in such scrips because you will lose a lot of money in slippages.
  5. Never write naked options, it is the quickest way of blowing up your account.
  6. You can earn a steady income by writing options against the underlying stocks you hold. However, write with caution.

Tags: nifty options, options trading, nifty calls, nifty puts


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