Many people think of options trading as a relatively new form of investment when compared to other more traditional forms such as buying stocks and shares. Derivatives have existed in India for a long time. But they become functional through exchanges only. Around 80 percent of derivative trading happens in the options market and the rest in futures. Earlier, the options were available in the market termed as the ‘’Badla’ system. Badla was later banned by the Securities and Exchange Board of India (SEBI) in 1993, effective March 1994, amid complaints from foreign investors, with the expectation that it would be replaced by a futures-and-options exchange.
The place where most of the buying and selling of Options contracts takes place is called the Options Market. The Options Market introduces the investors to more strategic and financial scopes than they can get by simply buying, selling, or short selling stocks. Options are considered powerful as they can enhance an individual’s portfolio. If you buy an options contract, it grants you the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date. A call option gives the holder the right to buy a stock and a put option gives the holder the right to sell a stock. The options market in India started in 2001 however, the volatility struck later by 2006.
Type of Options trading
There are various types of options available in the market, which can be categorized in many ways. Call and put options are the two most important and popular categories of option which are well known among the market players.
Call Option gives the holder the right, but not the obligation to buy the underlying security at a strike price and the put option gives the right, but not the obligation to the holder to sell the underlying security at a strike price.
The predetermined price that the buyer of the put option can sell at is called the Strike Price.
The other two commonly known Options types are; American and European Options. The American and European options offer similar features but have remarkable differences. The American style options can be exercised any time before its expiration date. Whereas, the European style options can only be exercised at expiry.
There are a lot of positives in the pros vs. cons of options trading. But there also are inherent risks. Here are some advantages and disadvantages that every potential options trader should consider.
Advantages of Options Trading:
Options trading is a strategy that offers many advantages. There are many advantages of trading options over the future and cash. Some are listed down below-
Options come up with huge leveraging power. Leveraging refers to the use of various strategies to maximize potential profits. Here you can create potential for bigger gains using a smaller amount of capital. A trader or investor can get an options position equal to a stock position at a much lower margin. For example, in order to purchase 200 shares of a stock at price 80, an investor requires paying Rs. 16000. However, if he was to purchase call options of equal weightage, the premium required would be around Rs 4000. So we can have a fair idea of options cost efficiency.
High Return Potential
Options trading possesses and offers returns way higher than what shares on cash offer. If we had chosen the right strike, the simple stock buying would pay equal profits as the options. Just as we are getting options on a lower margin and getting the same profitability the percentage return is much higher comparatively.
Options trading is known as a risky trading. But at times options allow you to create strategies with limited risk; one such strategy is hedging. Options are used widely to hedge the positions. In options, you already be aware of your risk as; Maximum loss= premium paid to buy the option.
More Strategy Available
The options market has numerous strategies available for you to choose to trade. You can combine the trades and create a strategic position with the help of call and put options of different expiries and strike prices.
Disadvantages of Options Trading:
Just like there are two sides to a coin; the same way Options trading along with its highly rewarding characteristics comes with many other disadvantages. Let’s go through some of them are-
Stock options have less liquidity. Each stock will have options trading at different strike prices and expiries which makes it very difficult for a trader to make entry and exit from the trade.
Options trading costs more expensive as compared to future or stock trading. The brokers charge a full-service brokerage. You may achieve an opportunity from some discount brokers to trade on lower commissions.
While you are holding options you are losing the time value of it. Time decay is the rate of decline in the value of options contract with passing time. As the options expiry date comes closer, the time decay accelerates and there’s less time to realize profit from the trade. The value of your option premium decreases by some percentages each day irrespective of movement in the underlying.
Non Availability of All Stock Options
Not all the stocks need to be registered with the exchanges. Many stocks do not have options for contracts. This acts as a challenge for a trader to hedge his position with options strategies.
Options are easy to buy and sell in any situation. Along with great rewards, comes greater drawbacks. The more time you invest in studying and researching the market, the more you understand and experience. Time is a key thing in trading the options as time decay runs against the buyer of the option. Trading cost is also a critical thing to consider while trading options. Options trading is more difficult to understand for a layman so you need to be careful while trading options.