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Why To Trade in Options

This document discusses reasons for trading stock options. It explains that options can generate profits when the underlying stock price moves up, down, or sideways. Options allow traders to profit from market movements with limited capital and risk. For example, an option trader could make a 400% profit on a 10% stock price change by investing only 2% of the capital needed to purchase the equivalent number of shares. Options also enable traders to hedge positions at a lower cost. While options can provide high returns, they also carry risks like time decay and loss of entire premium if the stock price does not reach the strike price.

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PareshRatanKundu
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83 views

Why To Trade in Options

This document discusses reasons for trading stock options. It explains that options can generate profits when the underlying stock price moves up, down, or sideways. Options allow traders to profit from market movements with limited capital and risk. For example, an option trader could make a 400% profit on a 10% stock price change by investing only 2% of the capital needed to purchase the equivalent number of shares. Options also enable traders to hedge positions at a lower cost. While options can provide high returns, they also carry risks like time decay and loss of entire premium if the stock price does not reach the strike price.

Uploaded by

PareshRatanKundu
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Why to Trade In Options- There are two primary drivers for stock options.

They are speculation and


hedging. Options primarily started with hedging tool but once its potential was realized as a quick money generator, it
was started as a tool for speculation. As per a report, options are done more for trading than for pure hedging. There
are complicated products created on options with the objective of making lots of money.
While underliers like stocks can generate profits only when its value goes up, options can generate money when the
stock is in uptrend or downtrend or even in the sideways market.
Unlike stocks, options can help you generate money irrespective of market movement.
Now let's understand why traders use options

1.Trading(Speculation): Profit with options can be very high with limited risk. For smart traders who can predict
market movement either up or down can buy options instead of stocks with much lesser capital for the same amount
of profit as stocks. Yet their loss is limited.

For example:
If value of a stock is 100
Capital required for buying 1000 stock is, 100,000
Movement of 10% will yield, 10,000 (brokerage and other charges included)
Maximum capital at risk -100,000.

For Options:
Capital required (only premium) - 2000 (with assumption of 2 per share)
maximum profit- with 10% movement. 10,000.
Net profit 10,000-2,000 = 8000 (brokerage and other charges included)
Profit% - 400%
Maximum capital at risk: 2,000
In the said example for a trader, stocks will return 10% while option will return 400%.

This scenario is extremely simplistic, there are various other factors. Please refer to advantage & disadvantage of the
stock option.

2.Block your requirement with limited capital: From the definition of option explained in previous tutorials, it gives
the buyer an option to buy some thing at the pre-agreed price without any obligation. By doing so, you are saved from
any violent price fluctuation beyond strike price. However, if it moves against, then you always have the choice to not
exercise option with limited loss.

3.Hedging: It acts like a hedging tool and helps you to limit loss in case of unexpected movement of stock price. For
example, you hold some stocks and you like to limit the loss in case market crash, then you will buy put options. It acts
as insurance to your capital.

Advantages of Options:
1.Its a good hedging tool.
2.Leverage. With very small capital, trader gets advantage of underlier's stock movement. In the example mentioned
above, when a stock returns 10% option returns 400%.
3.You can trade option any time when your objective is met. You do not have to wait for T+2.
4.Risk or maximum loss is limited.

Disadvantages of Options:
1.Options value moves to zero value on expiration date. If there is no movement in stock price then entire capital is
lost. Refer to previous tutorials.
2.If stock price goes below the strike price, entire capital is lost.
3.Corporate action like dividend, bonus etc are not applicable for option holders.
4.Options are very complicated. Understanding time value is difficult.
5.Options are generally bought in pairs. This results in lots of brokerage & taxes.
Other things to know about options.

1.They are short term trading therefore capital gain tax is applicable.
2.Its a sort of zero sum game. Means that somebody's profit is someone else loss.
However in some case, it could be win win when you are buying against somebody hedge.

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