Apart from Futures & Forex Trading & Stocks Trading & Commodities Investments, there is one more thing which is as accurate when it comes to trading, & that is Options. It usually would have been noticed in an often repeated phrase/term F&O.
Options have now became one of the most traded Derivatives of all times in the world!
Lets first understand what a derivative basically is....
Definition Of A Derivative!
A Derivative is a financial instrument which derives its value from an underlying asset!
It might seem complex at first. So let me explain with an example;
So, let's suppose that there is one "Treasure Box"
Which Is Empty!
So now, what's the value of the key of that "Treasure Box"?
Probably Nothing!
Right?
& NOW If I say that around A Million Dollars In Cash is Available in that same Treasure Box!
Then, NOW what is the value of the same key?
We can confidently say A Million Dollars!
Isn't it?
So, HERE,
The KEY is a Financial Instrument, which have derived its value from the underlying asset & we can say that the underlying asset is the money present within that Treasure Box Or we can say The Treasure Box, itself is the underlying asset, here.
So I hope that you understood the term "Derivatives".
Well, now....
Derivatives are of 4 types:
- Forwards
- Futures
- Options
- Swaps
Options is something which derives its value from the share(s) of a specific company!
As we go ahead through this blog we'll dig more deep into understanding about What Exactly Options Are; What Are They For & How Do They Work In REALITY! & The Types Of Options; etc. etc. So Everything will make sense as we go through this blog.
So let's begin with understanding the concept of Options!
What Are Options? (Basic!) (Understand With An Example!)
Options are often known as an insurance for stocks/shares. It basically protects one from the losses &/OR it moreover limits one's loss which can be faced by anyone.
Let's take an example to understand this term properly!
So lets suppose you want a TV & the current price is 1000$ & you got a news which says that the same TV will be of 1500$ within a week as per of its tax prices are going to rise & certain charges may be added. So now you go to a store & look for the TV & you realise that it's out of stock now &'ll be back at the store a week later. Now what are you supposed to do?
[Yeah! Ofcourse, there are other stores nearby; but just to explain the term 'Options' let's continue with this example....!]
So you went to a worker of the store & booked the TV Set. In this scheme, no matter what'll be the price of the TV a week later maybe but you'll get the TV at the same price you booked it at. So for booking you are supposed to pay the premium/booking amount which is 10% of the price of the item (10% for in this example). 10% of $1000 is $100. So you payed 100$. Now after a week (when TV will be back at store) you have to pay the remaining 900$ & get your TV at a total of 1000$.
Fine!
The deal seems great!
Now let's say that after a week the price of the TV decreases & comes to 800$ instead of increasing. Now what'll you do? Now you can either pay 900$ more to exercise/complete the previous booked order or else just let 100$ go! & instead buy the same TV at 800$. Here we face a loss of 100$. I know! But if we payed 900$ then we'll face a loss of 200$. You can clearly see which one's better. So in options you have an option whether to or whether not to use your RIGHT! The right you got here was that you can buy the TV at a fixed price on a fixed date & we know that one only uses his/her right if they'll make a profit. So you didn't used your right because you were facing a loss.
& the only loss we face in options is the booking amount or the premium payed!
You know, this was kind of a Non-Financial sort of an Example & also very basic. But don't worry because now within a while we'll understand about, How Options Actually Works In Reality! &'ll also dig deep down in &'ll understand important terms, we are supposed to!
(So CONTINUE READING!)
But before we get to that part we have to understand in what form are options traded!
So, here we go.......
In What Form Are Options, Traded? (Basic Definition!) Types Of Option Contracts!
Options are traded in the form of futures & have lots of shares, like futures, do!
It'll make more sense within a while now.... (as in the next topic it's explained with an example!)
You May Also Read: What Are Futures? (IN DERIVATIVES! F&O)
The One's who don't know about, what futures actually are.... I'll encourage you to read one of my recently published articles based on Futures, entirely. I might be covering a little bit about futures within this article, too. But it's just not all about it. We have an article/blog which solely talks about Everything In Futures you need to know, so go check it out now to understand options better!
Thank You!
So as we've now known that futures & options are quite similar then you may have an idea of the types of options contracts & about their expiry.
Then Yeah! You are kind of correct!
The option contracts are of 3 types (month wise....) Current Month/Near Month, Next Month & Far Month! & They all expires on the last Thursday of the Month! But just in case if there is a holiday on the last Thursday of a specific month when an Option Contract is supposed to expire then don't worry because it may expire a day earlier (on Wednesday) during the market hours or while it's closing!
Well, thats how it works!
But one more thing is there when it comes to option trading & that is that,.... there are weekly traded Option Contracts, as well. Which expires every Thursday of every week. It seems really cool! We won't really dive into this portion a lot!.... & all your confusions will hopefully be cleared in the upcoming portion of this blog! So everything will make sense within a while as of now I'm starting off with an example....
So here we go,
How Options Actually Works In Reality? (Example!)
Let's suppose, that there is a company named xyz & it have it's share currently trading at 1000$. & there is a news which says that the company xyz may launch a highly demanded product in public. So the share price of that company xyz, sure will have a positive impact, but only if the company actually launched that product. So in this case you don't want to buy the share because it's literally very confusing, like— nobody knows whether if these all news & all are just rumors or if it's actually true?!
So what can you possibly do in this case?
Well, you can buy an option contract, for sure!
So as I said, options are traded in futures. Which means it have a lot size. So let's say that, for the company xyz Option Contract, the lot size is set of 10 shares. Hence, the price of the entire Option Contract is $10,000 (1 share = $1000; 10 shares = (10*10,000) $10,000).
& again like futures the contract will expire on a specific day; Which means, the Option Contract will have a fixed date of expiry & a fixed price often known as strike price (in options) & on that price upto that time you have the RIGHT to buy 10 shares of the Company xyz!
So let's say we've bought a Current Month/Near Month Option Contract.... which expires within a month!
Ok! So, it've been a month, now.
& the company have not launched any product till now! In fact, now the price of the Company xyz's share has decreased somehow to $600 from $1000.
As of now is it's expiry!.... So it is upto you whether you want to exercise your Option Contract Or Not!
Exercising your Option Contract means going ahead with the Contract & accomplishing the deal. Moreover, it basically means that you wanna use your right of buying the shares of xyz company at the price of $1000 or not. & Ofcourse, you won't in this case! Because we are literally facing a loss! & Instead of that you can literally buy the share itself now trading at 600$. So why bother buying at $1000.
So let's say you didn't exercised the contract. So the loss was basically of just $1000. & remember the loss is of $100/share (1000$ for 10 shares). But if you bought the shares instead of the Option Contract then you would have faced a loss of 400$/share.... & $4000 on 10 shares. So here you successfully limit your losses to $100/share while you could've faced a loss of $400/share. So you reduced the risk!
BUT,
Now.... let's say that if the share price instead would have rised to 1400$ (maybe B'coz the company've launched the product or something). Then you're Option Contract would have worth $14,000. & Then ofcourse you would have exercised it! Right?
Let's see what would happen if you exercise it....
So now, as you've decided to exercise the contract, then you can buy 10 shares of the company xyz at the price of $1000/share who's actual share price is of $1400. Hence, 10 shares will cost you $10,000.
Ok! So now don't get confused here. I know that in the "TV set" example you paid the remaining amount. But here, (in the reality) you need to pay the entire amount & that is 10,000$ (10,000$ in this example)!
So, you paid 10,000$ & recieved the shares of worth $14,000. Hence the profit is of 4000$.... but now deducting the extra $1000, we paid to make the deal/to buy the RIGHT! So, we made a profit of $3000.
So what I'm trying to explain here is that in Options we for sure can reduce/limit the risk but we also somehow reduce the profit.
You know, the premium paid is basically the amount we pay in advance to buy the RIGHTS!
& also we can say that the premium paid is the loss in both the cases (regardless of you facing a loss or a profit in your investment!) But I think, because Options kind of limit our loss as we can always face a loss of more....! So it's kind of a profitable deal! But it always depends on the kind of investment one makes....like—if it's actually going to be profitable or not!
What Is Call Option & Put Option?
A Call Option is basically as the term "Call Option" itself might suggest, is just a calling of an option.... you know a buyer wants to buy an option so it's calling it! Ok! That was weird! It'll make sense within a while....
So let's make it a bit more transparent;
Well, in a Call Option there are 2 main people who are making a deal (a contract) among themselves.... who are.... one is a Buyer & another one is a Seller.
This is very obvious, though!
Now, here the buyer will have the Right to buy a specific share of a company on a fixed price at a fixed time. & it is completely upto the buyer whether if he/she will exercise the contract further if it reaches its expiry.
& one does it (exercises the contract) by having a look at the current performance of the share & only exercises it if it's profitable to them.
Now for like in the last example, if you remember which I discussed a while ago, of the company xyz....—You were the Call Buyer! I mean now you know that you were the Call Buyer. Because it was upto you if you want to buy the company xyz's shares on expiry or not. & as I said, one only exercises it, if they are making a profit & YOU DID EXERCISED IT TOO, when the share price increased to $1400 from $1000 but do you remember you didn't while it decreased to $600.
So, there is no obligation to the Call buyer. The Call Buyer have the right & also an option to buy or to not to!
While, on the other hand the Call Seller have the obligation.... Like if the call buyer WANTS to buy the shares then the Call Seller just have to sell them, regardless of the point, whether it's a profit or not for the Call Seller, itself.
& Put Option on the other hand, is the exact opposite of the Call Option. The term "Put Option" is suggesting putting down an option or selling the shares of a company but having a right to sell it on a specific day at a certain price & it's upto the Put Seller to either sell it or not.
So as we know that the two main people making the deal (contract) is the buyer & the seller.
The seller here have the shares the buyer wants but as it's an Option Contract it is going to expire on a certain date & the seller will have the opportunity to track the progress of the company's shares (upto the expiry) & then sell it if it's profitable for him/her.
For instance, let's say you have a Put Option Contract. & you have 10 shares of the company abc. & the lot size of the Option Contract is also of 10 shares only & each share of the company abc is currently trading at 1000$ & the contract'll expire within a month (Near Month/Current Month Option Contract). So after a month you saw that the price of the share of the company abc have increased by 500$. So will you exercise your Option Contract.
No!
B'coz why would you sell 10 shares for just 10,000$ (1000$/each) when they are trading at 1500$/each. It's a loss for you if you exercise it. Where as if you keep it & if you sell the shares individually then you'll get a profit of 500$ per share (& a profit of 5000$ on 10 shares).
So you have the right to sell the company's shares on a specific time at a specific price.
& the Put Buyer on the other hand have the obligation to buy the shares if you sell them no matter if it's a profit for him/her or not.
& as you might have an idea of now that the profit of a seller in both the cases (Call Option Contract & Put Option Contract) will result in the loss of the buyer & the profit of the buyer in both the cases (Call Option Contract & Put Option Contract) will result in the loss of the seller.
So these are the 2 types of the Option Contracts one can trade in!
Here's an image (I have already provided it in the beginning of the explanation) which'll make it easier for you to understand Put Options and Call Options.
Basic Differences & Similarities Between Futures & Options (F&O)!
Throughout this blog you might have been in a misconception of futures being as same as Options. But it is just not! However, I've still several times mentioned here some phrases such as "like futures in options also......."!
Well, let's just cover some similarities between Futures & Options, first!
- Both, futures & options contracts can be traded before expiry.
- Different Companies have different lot sizes!
- Not all companies offers futures &/or options to trade.
So just to mention a few! These were some similarities! (Basic Similarities!)
DIFFERRNCES BETWEEN F&O!
& the one & only major difference between futures & options is that in Futures there is an obligation— like the person owning the contract must buy it by its expiry! While in Options, one is completely free of the obligation in a certain contract (Call Buyer have no obligation & Put Seller have no obligation! & also the one with the RIGHT have an OPTION to either use the RIGHT or not to!
Have I Ever Invested In Options?
& like always the answer is again
"NO"! I just wrote this article//blog on the behalf of my research!
The information provided here might not be 100% accurate!
& Moreoever I Am For Sure Not At All Recommending/Suggesting Or Giving Any Piece Of Advice To Anyone To Invest In Options!
Anybody who'll invest will do it on his/her own responsibility OR at their own risk!
I JUST WANTED TO MAKE Y'ALL FAMILIAR WITH THE CONCEPT OF "OPTIONS", NOTHING ELSE!
But I just want to share my views on f&o as well. So here it is what I think of'em. But again, it's just my opinion; so, you don't really have to go with it! I really am not recommending something to you! *INVEST AT YOUR OWN RISK!*
What Do I Think Is More Profitable? Futures OR Options!
Well, according to me! Both are quite profitable but ofcourse it may cause a loss. You know there is a chance of a loss, literally everytime! But Options, to me, for sure kind of seems more profitable. Because it limits our losses! But I don't know & it for sure does not mean that futures are too bad for investing!
So both are kind of Fine!
NO RECOMMENDATIONS, though!
But anyways, you let me know if you'll ever invest in Options?
Make sure to LEAVE A COMMENT!
&
Thanks For Reading!
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