What Are The Types Of Options In The Stock Market?
What Are The Types Of Options In The Stock Market?
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Options Trading is a way to diversify your portfolio and protect yourself from losses. With options, you get the right (but not the obligation) to buy or sell an asset at a predetermined price. They can be anything tradable, like stocks or commodities. Some of its most notable features are fixed strike price and contract size, defined expiry date, and freedom to opt-out and not buy or sell an asset. It is an exciting way to explore new investment opportunities and potentially earn profits. Intrigued? Now let’s understand the different types of options you can trade in the stock market.
Types of Options
Options are of two types: call options and put options.
- Call Options
Call option contracts refer to the ‘right to buy’. If you invest in a call option, you get the right to purchase a stock at a predetermined price, known as the strike price. This kind of contract has an expiration date, before which you can decide to buy the stock whenever you feel it’s the right time. It is a suitable option if you expect a future rise in the stock’s price. When the price increases, you can exercise your right to buy and purchase the stock at a specific price. Purchasing a stock when the strike price is below the market price helps make a profit.
Working:
To purchase a call option, you must pay a percentage of the asset’s price as a premium. Once purchased, deciding to exercise the option solely depends on your discretion. You can let the call option expire if you deem it unprofitable. However, you will lose the premium you paid when entering a call option contract. On the other hand, if you see the option as profitable and want to exercise the option, the seller is obliged to sell the asset. While a call option can provide unlimited profits, the loss is limited to the paid premium. It benefits you in the rising market conditions. You can exercise it at a predetermined price or sell it if it exceeds your break-even price.
Let's say you purchase a call option for Company XYZ stock with a strike price of INR 100 and an expiration date of one month. If the stock price rises above INR 100 before the expiration date, you have the right to buy the stock at the predetermined price. For instance, if the stock price reaches INR 110, you can exercise the call option, buy the stock at INR 100, and potentially make a profit from the price difference.
- Put Options
A put option gives you the ‘right to sell’. You can sell a stock option at a strike price before its expiry date. If you expect its market rate to fall in the future, placing a put option would be a suitable decision. As the underlying asset's market price drops, you can exercise your right to sell it at the strike price. You can profit by selling the stock when the strike price is higher than the market price.
Working:
Similar to a call option, a put option also requires a paid premium. When you purchase one, you have the right to sell an underlying asset at the put option's strike price. It is a suitable option if you believe the stock’s price will decrease in the future.
For instance, you buy a put option for Company ABC stock with a strike price of INR 100 and an expiration date of one month. If the stock price falls below INR 100 before the expiration date, you have the right to sell the stock at the predetermined price.
Let's talk about some key terms in the world of options. When the price of the asset drops below the strike price, it's called "in the money." On the flip side, when the price goes higher, it's referred to as "out of the money." And if the strike price equals the current price plus the premium paid, it's called "at the money." Now, if the option goes out of the money, it's generally better to avoid exercising it to prevent losses. Keep in mind that you'll lose the premium you paid when entering the contract.
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Conclusion
Options are like these financial tools that let you speculate and hedge against the ups and downs of the stock market. You've got two main types of options: call options and put options. Call options give you a shot at maximising profits when prices go up, while put options come to the rescue when prices take a dive. So, remember to trade wisely and stay informed. Options, in all their variety, can be a game-changer in your trading journey. Ready to take on the options adventure? Good luck!
Disclaimer: The information provided here is for general informational purposes only and should not be considered financial or investment advice. Investing in financial markets involves risk, and individuals should carefully consider their financial situation and consult a professional advisor before making investment decisions.