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What the hell are these options everyone is too much crazy about?

In Simple words, options are derivatives. Now, what is derivative? Derivatives are instruments that themselves has no value but their value is derived from another instrument known as 'Underlying instruments'. and stock options are called underlying securities.

Types of Derivatives:-

1. Futures

2. Options

3. Forward Agreements

4. Swaps

5. Warrants etc.

Let's talk about it from its origin going to boring history if you want can skip.

Thales was the first person who has used for the first time around 600 BC (2621 years ago).

Tulip Mania was the period (Feb 1637) when contract prices of some bulbs were too high it was kept on increasing because of that people are kept in trading options of tulips and it ended up in a bubble. We can say the first bubble of options trading.

Japanese rice trading (1697 to 1939) was the world's first organized commodities future exchange and was specialized in rice.

In the late 1800 brokers and dealers started to place adverts to attract buyers and sellers of options contracts with a view to brokering deals. The idea was that an interested party would contact the broker and express their interest in buying either calls or puts on a particular stock. The broker would then try and find someone for the other side of the transaction.

In the year 1848 Chicago board of trade (CBOT) was established they centralized the system and added more standardization to it for the farmers and after that in1865 Standardized futures were created in the future markets.

In April 1973 Chicago Board Options Exchange (CBOE) was created and it accelerated trading from there.

In 1977 Started offering Put options.

In 1983 Started offering options on the interest rates.

In 2005 issued the world's first weekly options and now it became the most traded option across the globe.

In 2020 Lockdown due to covid again future and options trading reaches a record high. Total futures trading rose 32.7% to 25.55 billion and total options trading rose 39.3% to 21.22 billion compared to 2019. For the third consecutive year broke the record on trading activities. The US alone has seen a jump of 52.4% to 7.47 Billion contracts in 2020.

Let's put the end of boring history and talk about what the hell is options and futures?

Before answering this question I will talk about why we need this and why it was created? As per the research I have done and interacted with traders it was created to transfer the risk means mitigate or transfer the risk even we talk about equity itself.

Let me now talk about all important contracts one by one.

1. Future Contracts:- It says to do today what you might do in future. You lock the product today what you want to buy in future. What's the benefit of doing this? The Farmer if he feels in future he might not get good prices for crops or the buyer thinks at future prices may shot up they will fix the contract both can be relaxed and be certain about the future. In terms of trader, he will speculate based on whatsoever reason and can buy or sell the contract. By giving up some profit buyers and farmers will have a consistency that will be extremely great they can sleep peacefully at night and all worries will go to speculators and the biggest benefit will be stabilising the market.

2. Equity diversifies capital risk not even talking about the stock options only equity. how it offloads risk is when the company starts and have some growth VC or Angel Investor puts lots of money to make it sustainable and have great future growth in exchange for that they will buy shares of the company and after some years they will come up with IPO and offload that risk to other investors.

3. Equity options if you have bought shares of Apple and if it goes down and you have put options for the same your risk will be managed after x amount of loss you will not have further loss till the expiry of the put option. Call options are for the traders who have short sell the equity even if it goes to 10x they will have limited risk or investors who want to invest and but are not sure about the near future can buy a call option if price shots up still can buy for the strike price.

Hmm okay, I understood a bit about options now tell me why to use options?

Before answering this question again I will talk about the type of traders so, you can relate with them.

Two types of traders:-

1. Investors who want to offload risk as options are meant to be offload risk

2. Speculators who want to make money by speculating the price.

Two types of options:-

1. Call Options:- Right but not obligation to buy a specific stock or commodity at a specific price, on or before the expiry date.

2. Put Options:- Right but not obligation to sell a specific stock or commodity at a specific price, on or before the expiry date

In general expiry date in the Indian market for stock options and monthly index option is the last Thursday of the month.

When to use it?

If you are an investor Buy put to hedge (offload risk) on long trade and buy call to hedge (offload risk) on a short trade.

If you are a speculator trade the puts and calls to make money by predicting the future (Keep this in mind you are talking about the risk offloaded by investors or farmers). Buy Calls to speculate bullish trade and buy puts to speculate bearish trade or you are sellers (speculator only don't confuse speculator can buy or sell options). Sell Calls to speculate no momentum or bearish and Sell puts to speculate no momentum or bullish.

Wait understood on risk offload part now tell me how will I make money If I am a speculator?

You can buy an option by just paying a premium (most of the time it is a fraction of the amount from stock price) If you have bought a call option and if stock prices go from 100 to 120 and you have a stock option of strike price 110 you will have at least 10₹/$ as profit per share and premium might be around 1₹/$ per share 10x return (Yes it has much more things but removed for simplicity). If you have bought the put option and if stock prices go from 100 to 80 and you have a stock option of strick price 90 you will have at least 10₹/$ as profit per share and premium story will be the same as call. As discussed by buying call you are bullish and by buying put you are bearish on a particular stock, index or commodity.

You can sell an option by paying a big amount compared to buyers still having a lower price compared to stocks. As discussed in selling if you are selling call options you are bearish or neutral and if you are selling put options you are bullish or neutral.

Selling an option or selling equity before buying know as short trade.

Cool now tell me how can I take the trade?

There are multiple ways you can take the trade let's start with the most important one The option chain.

Option Chain:- Where all of the information regarding options can be found here.

E.g. of the Option chain of Nifty50, you can get live Option Chain from multiple websites If you want to check out this it's on the official website of NSE (https://www.nseindia.com/option-chain).

If you see the left side of the Strike Price all of them are call options and if you see the right of Strike Price all of them are put options.

Now only focus on the left side (call options) Bid Qty and Bid Price (Bid is basically price and qty people sell and in simple words bidding the price in which they want to sell) and Ask Qty and Ask Price (Ask is basically price and qty people buy in simple words asking the price at which they want to buy).

LTP (Last traded Price):- Last price that a trade occurred in option contracts.

In some of the places you might find out Pos basically, it will say how many positions you have in that option contract.

Strike Price:- It is the specific price at which one can buy or sell the stock.

As mentioned if you have bought CE you have the right to buy and PE you have the right to sell. If you take 17500 CE at Ask price of 181.4 means you are paying 181.4 to buy the right (not the obligation) to buy the index.

The same goes with the Put side only change is you are buying the right (not the obligation) to sell (as per me not needed should be understood if not comment down will edit this).

Volume:- Number of contracts traded in that session (in a day).

Open Intrest:- No. of contracts are in circulation at that time and in simple words how many contracts are available overall. don't get confused volume means how many traded one might be traded at multiple times in a day.

The Greeks:- Set of Stats values used to measure the various component of risk in options.

mostly used to estimate future price movement in the option.

Where to find this? It's available on almost all OI Chain websites. One of the best places where you can find this is https://www1.niftytrader.in/option-pricing-calculator

Let's talk about the greeks to understand things much better way.

IV (Implied Volatility):- An estimate of expected volatility over the lifespan of the options.

Increase a lot when a sudden move is expected. An investor buys to offload the risk in this case that shots up the price and most of the time option sellers get benefited by this.

It is a major component of volatility.

VIX increase in a bearish market and decreases in a bullish market. You can find this out be searching India Vix on google.

Delta:- The most important greek.

Reflects the relationship of the option price moves relative to a 1 point move in the stock.

All of the greeks are summed up in this and if you want to only go for one greek go for delta.

If Delta is 0.31 and the Stock price moves 1₹ so, the option price will move 0.31₹ and if the stock price decrease 1₹. Option price will decrease 0.31₹. Not guaranteed might be depended on demand-supply but the overall calculation will be the same.

Theta:- Reflects the time portion and rate at which option will reduce the premium at a scenario when the stock remains at the same place.

Premium will decay daily based on the rate of theta when stocks remain at the same place.

Mostly depends on expiry time nearest expiry will have much more impact on theta compared to the far expiry.

Vega:- Reflects the amount of premium increase or decrease based on a 1 point move in implied volatility.

Its impacts on premium just by increasing implied volatility your option premium will increase without movement of stock vice versa if implied volatility decreases.

Gamma:- Rate of increase or decrease in delta based on 1 point move in stock price.

when option strike price will move further deeper in the money delta will increase and if moves out of the money delta will decrease.

It is like Delta of Delta for speculators. It will give extra money when you buy OTM and turns into ITM your premium will also shot up.

Option Pricing Principles:- In option at any given time an option has two types of values

1. Intrinsic value:- Inbuilt value

2. Time Value:- Premium additional to intrinsic value mostly fluctuate based on the remaining time.

Let's do an unboxing of time value. Time is "Premium". It can decay when we get closer to expiration. They take a premium to cover the risk. It's like an insurance policy you have to pay more when you have more time left and more possibilities of claiming the insurance policy.

This premium seller earns in exchange for taking a risk. Mostly influenced by time and volatility and they have minor influence by interest rate and dividends.

More time = More probability (or risk) of stock to move higher or lower. That's why higher premium.

Interest rate:- Additional premium paid to offset the cost of ownership of the underlying contract. It is a very minimal impact because that most of the traders don't bother about it.

If rates rise call option premium increase and put premium decrease.

If rates fall call premium decrease and put premium increase.

Dividends:- if dividend changes it will have an impact on options as well most of the time dividends stay constant but fewer times it changes.

If dividend rise calls premium decrease and puts premium increase. If dividend fall call option increases and put option decreases reason being dividend-adjusted with the stock prices.

Types of options based on this

1. ITM (In the Money):- This option has intrinsic value.

2. OTM (Out of the Money):- The option does not have intrinsic value.

3. ATM (At The Money):- Option strike price which is trading at the closest to the actual price of the stock.

Formulas for Call options to find out Intrinsic and Time value

To count Intrinsic value use the formula Stock price - Strike price = Intrinsic value.

To count Time value use the formula Option price - Intrinsic price = Time value.

Formulas for Put options to find out Intrinsic and Time value

To count Intrinsic value use the formula Strike price - Stock price = Intrinsic value.

To count Time value use the formula Option price - Intrinsic price = Time value.

Cool Understood now tell me how to find option premium?

Black - Scholes is the option premium formula found in 1973.

Used to calculate the target premium for an option

Here comes formula