Is Options Trading Profitable? There are several questions that arise in the traders’ minds about investing in the stock market, and the entire stock market is a vast ocean. Let’s see Is Options Trading Profitable or not?
What are the Options?
An option refers to a financial instrument that is based on the value of the underlying securities, such as stocks. An options contract offers the buyer an opportunity to buy or sell, depending on the type of contract they hold.
Every contract will have a specific expiration date, and so the holder will have to exercise the option before that date.
The stated price on the option is called the strike price.
Options are generally bought and sold through online or retail brokers.
Types of Options Trading:
There are two types of options trading available in India:
Call Options:
A call option is basically a two-party derivative contract.
Here, the call option buyer gets the right, but not the responsibility, to exercise his option to purchase a particular trade from the call option seller for a set period of time.
Understanding Call Options:
If you think that the price of a particular index is going to gain in the coming days rather than a specific share list, you can go for an index call option as a trader.
On the NSE, call options are CNX Nifty 50, CNX IT, and Bank Nifty, while on the BSE, call options are Sensex.
Put Options:
Put options allow the buyer the right, but not an obligation to sell a specific quantity of a stock at a specific price on or before the contract’s expiration date.
Understanding Put Options:
There are two types of put options namely: American and European.
American put options are more flexible because they allow you to close the trade before the expiry date of the contract.
European put options can be exercised on the expiration date.
Types of Call and Put Options:
There are four positions while trading in call and put options. They are as follows:
Buy a Call:
- Here, it is believed that the stock will rise, i.e., the particular stock is in a bullish trend.
- Unlimited reward.
- Risk or loss is limited to the premium paid.
- Only three things can happen here on expiry:
| Market price > Strike price | In the money call option | Profit |
| Market price < Strike price | Out-of-the-money call option | Loss |
| Market price = Strike price | At the money call option | Break-even (no profit, no loss) |
Sell a Call:
- Here, it is believed that the stock will fall, i.e., the particular stock is in the bearish trend
- Profit is limited to the premium paid.
- Risk is unlimited.
- Three things happen here on expiry:
| Market price > Strike price | In the money call option | Loss |
| Market price < Strike price | Out-of-the-money call option | Profit |
| Market price = Strike price | At the money call option | Profit in the form of the premium amount paid |
Buy a Put:
- Here, it is believed that the stock will fall, i.e., the particular stock is in a bearish trend.
- Unlimited reward.
- Risk or loss is limited to the premium paid.
- Three things happen on expiry:
| Market price > Strike price | Out of the money put option | Loss |
| Market price < Strike price | In the money put option | Profit |
| Market price = Strike price | At the money call option | Loss up to the premium paid |
Selling a Put:
- Here, it is believed that the stock will rise, i.e., the particular stock is in a bullish trend.
- Profit is limited to the premium paid.
- Risk is unlimited.
- Three things happen on expiry:
| Market price > Strike price | Out of the money put option | Profit |
| Market price < Strike price | In the money put option | Loss |
| Market price = Strike price | At the money call option | Profit in the form of the premium amount paid |
Differences between Call and Put Options:
Given below are the main differences between the two:
| Basis | Call Options | Put Options |
| Meaning | It will give the buyer the right but not an obligation to buy | It will give the buyer the right but not the obligation to sell |
| Reaction to dividend | Call options loose value when the dividend date is near | Put options gain value when the dividend date is near |
| Profits | Profits are unlimited | The profits are limited because the stock price will not become zero |
| Losses | Loss is limited to the premium amount paid | The maximum loss is the strike price minus the premium paid |
| Expectations of the investor | The buyer believes that the stock price will rise/ increase | The buyer believes that the stock price will fall/ decrease |
What are stocks?
Stock consists of all the shares into which the ownership of the company or corporation is divided.
In simple language, the stock is used to describe the ownership certificate of the company.
Differences between Stocks and Options:
Stocks and options both work differently. The following are a few differences between the two:
| Basis | Stocks | Options |
| Definition | Security which represents the ownership of a fraction of the company | A financial instrument that gives you the right to buy or sell shares of an underlying security for a set price at a future date |
| Ownership | Stocks represent ownership in the company | Stock options represent the choice to buy or sell a stock |
| Dividend/ Voting Right | Shareholders receive voting rights in the important matters of the company and the dividends are also paid by the company | Stock option holders do not receive any dividend and also do not enjoy any voting right |
| Investor type | Beginner, long-term, or hands-off investors | Active traders or advance investors |
| Expiry | It does not expire till the company exists. Hence, it is also referred to as an asset | They expire at a future date called the expiration date after which the holder cannot buy or sell. Hence, it is also referred to as an expense. |
| Valuation | The prices are based on primary market forces as well as other company fundamentals. | The prices are largely based on the price of the underlying stock, time of expiration, and other related factors. |
| Trading/ Investment | Investment instrument | Trading instrument |
| Benefits | Require less attention and possible dividend payments | Greater returns and hedge against volatility. |
| Risks | Might lose the entire principal and slower returns | Increased risk of loss. |
Some of the good and bad things about options and options trading:
Is Options Trading Profitable or Risky?
- Options are risky only if we fail to understand them.
- There is only a high-risk option when you are a complete seller.
- The risk to the buyer is only up to the premium amount.
- A proper hedging strategy or proper market judgment is required to control your risk as well as your loss.
Trading options is a zero-sum game:
- Options are like insurance policies and can be used as risk management tools.
Options are difficult to understand?
- Options are not difficult to understand because there are only two options- Call and Put, where you can only buy or sell.
It is very easy to make money with options:
- How to trade and invest successfully requires a lifetime of work, focus, and dedication.
- Here, the key is to find and maintain a high level of success in markets and to trade and invest according to your own risk tolerance, investment goals, and time horizon with proper risk management.
- Options cannot just be used for speculation but can also be used for hedging, leverage, and protection.
Selling options is like receiving free money:
- Selling options for collecting cash looks safe, but there is an unlimited risk attached.
Option sellers are only making money:
- The utter fact is that both buyers and sellers make a profit because without sellers, there would be no buyers, and without buyers, there would be no market.
- Options sellers win at times.
Is Options Trading Profitable than stocks?
Options trading is known to be less risky than equities if they are traded well and strategically.
Options are safer than equities since they require a very lower amount of capital than equities and are completely unaffected by the fatal effects of market fluctuations.
How can options be used to offset risk?
Options generally reduce risk through hedging. The following are some risk-aversion strategies:
Conclusion:-
Options are best for those who wish to enjoy the flexibility and reduce the risk by hedging.
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