Part 2 Candle Stick Pattern 1. Introduction to Option Trading
In the world of financial markets, traders and investors are constantly looking for ways to maximize returns while managing risks. Beyond the conventional buying and selling of stocks, bonds, or commodities lies the fascinating arena of derivatives. Among derivatives, options stand out as one of the most versatile and widely used financial instruments.
An option is essentially a contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price before or at a specified expiration date. This flexibility allows traders to hedge risks, speculate on market movements, or design complex strategies to suit different risk appetites.
Option trading is a double-edged sword: it can generate extraordinary profits in a short span but also result in significant losses if misunderstood. Hence, before stepping into this market, it is essential to understand the fundamentals, mechanics, and strategies behind option trading.
2. Basics of Options
To understand option trading, let us first dissect the essential components.
2.1 Call Options
A call option gives the buyer the right, but not the obligation, to buy the underlying asset at a predetermined price (strike price) within a specific period.
If the asset’s price rises above the strike price, the call option holder can buy at a lower price and profit.
If the price falls below the strike, the buyer may let the option expire worthless, losing only the premium paid.
Example: If you buy a call option on Stock A at ₹100 strike and the stock rises to ₹120, you profit by exercising the option or selling it in the market.
2.2 Put Options
A put option gives the buyer the right, but not the obligation, to sell the underlying asset at the strike price before or at expiration.
If the asset price falls below the strike, the put holder benefits.
If it rises above the strike, the option may expire worthless.
Example: If you buy a put option on Stock A at ₹100 and the stock falls to ₹80, you can sell it at ₹100, making a profit.
2.3 Strike Price
The pre-agreed price at which the underlying asset can be bought or sold.
2.4 Premium
The price paid by the option buyer to the seller (writer) for acquiring the option contract. It represents the upfront cost and is influenced by time, volatility, and underlying asset price.
2.5 Expiration Date
Options have a finite life and must be exercised or left to expire on a specific date.
3. Types of Options
Options vary based on style, market, and underlying assets.
American Options – Can be exercised anytime before expiration.
European Options – Can only be exercised on the expiration date.
Equity Options – Based on shares of companies.
Index Options – Based on stock indices like Nifty, S&P 500, etc.
Commodity Options – Based on gold, silver, crude oil, etc.
Currency Options – Based on forex pairs like USD/INR.
4. Participants in Option Trading
Every option trade involves two primary parties:
Option Buyer – Pays the premium, enjoys the right but no obligation.
Option Seller (Writer) – Receives the premium but carries the obligation if the buyer exercises the contract.
The buyer has limited risk (premium paid), but the seller has theoretically unlimited risk and limited profit (premium received).
5. Why Trade Options?
Traders and investors use options for multiple reasons:
Hedging – Protecting existing investments from adverse price moves.
Speculation – Betting on market directions with limited risk.
Income Generation – Writing options to collect premiums.
Leverage – Controlling a large position with a relatively small investment.
