How To Make Side Income By Trade in Options?
There are various ways for a trader to earn through trading in stocks. One of them is options trading. Here in this blog, we will discuss options trading and some of the strategies to trade in options.
What are Options
Options are the agreements that grant the buyers a right to buy or sell a security at a price fixed by them. It is not an obligation and the trader can decide what he wants to do before the contract expires.
The options help an investor hedge their risk and often are used against a weakening stock market. It is also used to produce recurring revenues. There are two types of options:
- Call Option – It is the contract that gives the buyer the right to buy and the seller an obligation to sell.
- Put Option – It is the contract that gives the buyer a right to sell and the seller an obligation to buy.
What is meant by Options Trading
Options trading means that the trader can purchase or sell a security at a price that is predetermined by the trader and within the specified time. Trading in options is a bit more complicated than stock trading but if the traders have full knowledge of options trading it can help them yield larger profits.
While making a trade in option the trader does not have to pay the full amount of security. Similarly, it can also protect from losses if the price of the security goes down.
Types of Options Trading
Call Options Trading
Call options are used to initiate a bullish position in the index. To buy a call option, a buyer pays a premium. As the price of the stock goes up the option premium increases and the trader books a profit.
Put Options Trading
The put options are used to initiate a bearish position in the stock. The premium paid for buying a put option increases as the price of the stock falls. The buyer of the put option benefits from this falling price.
Advantages Of Trade In Options
Options trading is very helpful to traders who have low initial exposure. The cost of acquiring an option is less than the cost of acquiring a stock. Another advantage of trading in options is that it is quite flexible and the traders can make many different moves before the contract expires. A trader can also benefit if he uses a strategy that limits the downside risk which may help them generate recurring income.
Disadvantages of trade in options
There are various disadvantages also to trading in options.
- This concept can be complicated for beginners and even some experienced investors.
- If the trader holds options for a longer time the time value decreases.
- Options are not available for all stocks, restricting the possibilities available to the trader.
- There is very less analytical information available on options contracts which makes it difficult for the trader to decide which contract to buy.
Strategies of Options Trading
Various strategies in options trading help traders increase their income. Some of these strategies are:
The Iron Condor Strategy is the most popular strategy among traders. It involves four options contracts with different strike prices but with the same expiry dates. In this strategy, the trader sells an out-of-the-money call and put and then buys the calls and puts more away from the current market price.
As the price difference between the bought calls and puts and the sold calls and puts is huge the trade receives a net premium for placing the trade. Trading using the iron condor strategy involves combining a bull put spread and a bear call spread.
A trader buys shares of Company X whose Lot size is 100 shares and was trading at ₹ 50 in November. To use the Iron Condor strategy the trader buys and sells the following.
- Invest ₹ 40 in one December put option with a strike price (at a cost of ₹ 50)
- Invest in one December call option with a ₹ 60 strike price (at a cost of ₹ 50)
- Market one December put option with ₹ 45 strike price (for a price of ₹ 100)
- Market one December call option with ₹ 55 strike price (for a price of ₹ 100)
When the trader buys and sells these options, he has booked a profit of ₹ 100, i.e., he has earned ₹ 200 by selling the options and paid ₹ 100 in options buying.
A covered call is an options trading strategy that consists of selling a call option on your current stocks. The covered call strategy is the most successful when the trader’s stock view is either neutral or slightly bullish. It is used by traders to hedge their risk of a long position.
The trader makes two actions with a covered call – they buy shares in stock then they sell a call options contract to buy shares in premium. In this, the trader gets to keep the premium amount no matter what happens.
The downside of this strategy is that the trader may have to sell if the owner of the contract decides to buy.
A trader buys shares of Company Y whose Lot size is 100 shares and was trading at ₹ 100 in November. The trader believes that the stock market will not be volatile in near future and predicts that the share price will rise to ₹ 105 in six months.
The trader can lock in the profit by selling one call option contract with a strike price of ₹ 105 that will expire in 6 months. The premium on this call option is ₹ 3 per share.
When it is the time of contract expiring the trader will exercise the call option only in the case when the share price increases and not when either the price decreases or remains the same.
The Protective Collar strategy is used when the trader owns a stock and sells a covered call while also buying a protective put. This strategy comes with very little risk and works well with a neutral position that wants to hedge against stock dropping.
One way through which the protective collar can generate income is by selling the call option for more than what is paid for the put option. If the price of the stock is neutral and the strike price on the call is not met the trader makes a small profit regardless of the movement of the stock.
A trader is holding shares of Company Z which is trading at ₹ 100 and its lot size is 100 shares. The trader protects himself from loss in case the stock moves downwards by using the collar strategy. He sells a call option at ₹ 110 with ₹ 5 premium and buys a put option at ₹ 90 with ₹ 5 premium.
At the time of expiry if the price rises to ₹ 120 the trader will exercise the call option and if the price falls to ₹ 80 the put option will be exercised.
Options trading is a complicated topic for someone who is just entering the field of the securities market but it can be highly rewarding if used in the right way.
To become a successful options trader, you need to do very thorough research and learn the various tactics that are applied to it. You can make you own strategy with Opstra (option strategy builder). Success in options is not only about picking good positions but also about protecting against risk.
A trader can also trade in multiple options to hedge their position to avoid a big loss. You can contact us at Venus Tradex for trading options.
Is Options trading risky?
Options are one of the riskiest trading assets as the premium prices are very sensitive and the price can make wide swings.
What is Open Interest?
It applies to the number of available positions on an options contract at any point in time. The open interest becomes zero after the expiration date.
What is Option Chain?
The option chain analysis is the matrix used to analyze the put and call strike price trading tasks. In one of our previous blogs, we described the option chain and various terminologies.
Is Options trading better than stocks?
Options trading is more complex than stock trading but it can help the trader make a larger profit if the price goes up.