Part 1 Support and Resistance1. Introduction to Option Trading
Option trading is a sophisticated financial instrument used widely in modern markets for hedging, speculation, and portfolio management. Options are derivatives, meaning their value is derived from an underlying asset, such as stocks, indices, commodities, or currencies. Unlike buying or selling the underlying asset directly, options give traders the right—but not the obligation—to buy or sell the asset at a predetermined price within a specific timeframe.
The global options market has grown exponentially, as institutional investors, retail traders, and hedge funds recognize the flexibility, leverage, and risk-management capabilities of options. They are integral to strategies ranging from simple protective hedging to complex arbitrage trades.
1.1 What Is an Option?
An option is a contract that grants its holder certain rights:
Call Option: The right to buy the underlying asset at a specific price (strike price) before or on a specified expiry date.
Put Option: The right to sell the underlying asset at a specific price before or on a specified expiry date.
Unlike futures or forwards, which carry obligations, options give the holder flexibility, making them versatile tools for both risk mitigation and speculative opportunities.
2. Key Terminology in Option Trading
Understanding option trading requires familiarity with certain fundamental terms:
Strike Price: The predetermined price at which the underlying asset can be bought (call) or sold (put).
Premium: The price paid to buy the option. This is influenced by time value, intrinsic value, volatility, and market conditions.
Expiry Date: The date on which the option contract expires and becomes void.
In-the-Money (ITM): An option with intrinsic value (e.g., a call option with a strike price below the current market price).
Out-of-the-Money (OTM): An option with no intrinsic value (e.g., a call option with a strike price above the current market price).
At-the-Money (ATM): An option where the strike price equals the current market price.
Underlying Asset: The financial instrument (stock, index, commodity, or currency) on which the option is based.
Volatility: A measure of the asset's price fluctuations, which directly impacts option pricing.
