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How does options trading work in the stock market?

 

How does options trading work in the stock market?


options trading options work as a contract between buyers and sellers for a fixed expiry date. If you buy an option contract, it gives you the right to buy the underlying asset on or within a certain date.

But you are not obliged to buy the underlying asset before that due date or on the same date, just the condition is that you have to pay your premium amount which you paid at the time of contracting earlier.

You can understand this with an example –

Example: Suppose you went to a shop to buy a Realme company TV, which is the latest model. Now you know from somewhere that realme company is going to change the rate of its TV next week.

Now you do not know whether the company is going to increase or reduce the rates of TV, but you have made an estimate that the rate is going to increase in the coming time.


But when you go to the shopkeeper and ask him to buy a TV, he says that all the TVs of this model have been sold and now this TV will come only next week. Now you think in your mind that next week the rates are going to increase, so I will have to pay more money...

In such a situation, the shopkeeper tells you that I will give that TV for you after a week at today's price, but you will have to pay me a booking amount.

Now you ask the shopkeeper how much booking amount he tells that this model is 50000 rupees, if you want, you can fix your booking for the next week by paying only 1000 rupees now and after a week you can come and take the TV by paying the remaining 49000 rupees.

Now you think that this is very good and you become very happy and leave by giving 1000 rupees to the shopkeeper.

Now when you go back to the same shop after a week, you ask the shopkeeper to give your TV, as soon as the shopkeeper brings your TV and you are paying the remaining 49000 rupees, then you think that before that you also ask the rate of TV how much the rates have increased now.

But you know that the rates of that TV have decreased instead of increasing, which has come down from 50000 to 45000 now. Now you feel a big shock

And now when you ask the shopkeeper to buy a TV for Rs 45000,45000, he says that I will give you a TV for Rs 1000,<>, but forget your Rs <>,<> that you gave as a booking amount.

Now you have two options, either you buy a TV by paying Rs 49000 or by paying Rs 40000.

Of course, you will buy a TV by paying 40000 rupees. But remember that you will not get your 1000 rupees booking amount.

In the same way, option trading works, the 1000 rupees you gave as a booking amount are called premium in option trading and the underlying asset to the TV.

Imagine that if the price of that TV had increased from Rs 50000 to Rs 60000, then you would have made a profit of Rs 10000 because that shopkeeper had to give you that TV for 50000 because you had contracted with him 1 week ago, whose premium amount is still with him and that is the proof of your contract.

Options trading is not so difficult to understand, you just need to understand the basic things.

By now you must have understood what option trading is and how it works.

When is the expiry date in options trading?

In options trading, the expiry date of each option is on Thursday. There are two types of expiry: weekly expiry and monthly expiry. Nifty and Bank Nifty have a weekly expiry while stocks have a monthly expiry which is the expiry date of the option on Thursday in the last week of the month.

You can buy or sell any option whether it is a call option or a put option before the expiry date or on the expiry date.

What happens as the option's expiry date approaches?

As the expiry date of your option nears, the price of your option premium keeps changing. If your call option has benefited and your share or index price is not increasing but is running sideways, then you will see that your option premium will gradually decrease.

Example: Suppose you paid a Rs 40 option premium on Monday and your underlying asset is not performing as per your estimates, then your option premium will go down, which will also reduce the value of your investment. It is possible that by Thursday, the option premium of Rs 40 will be 0.

Now you must be wondering why this happens, that means who reduces the price of option premium and why your money gradually decreases? The answer is theta (θ)

Yes, theta is the only thing that keeps reducing your option premium. But now you will ask that if the value of your option premium keeps decreasing, then where does its money go, then let me tell you that that money goes to the option seller.

One thing you should make clear in your mind is that in options trading, money does not come from the air, but goes out of one person's pocket and goes into another person's pocket. That is, if you lose, someone else gains equally and if you gain, someone else loses.

That is why in option trading, the one who learns wisely and follows the right strategy and trades makes big money.

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