Understanding Options

What is an Option:

It is the right to buy or sell but not the obligation.

For instance if you want to buy 1000 shares of TATA Steel at current price of Rs.500 hoping that the price would rise, you normally buy it by paying Investing 5,00,000 (500*1000). As the price rises, say it becomes Rs.600, then you may opt to sell booking a profit of Rs.`100 per share or Rs.1 lakh in total.

Instead, you can make an advance payment (premium) and hold on to 1000 shares of TATA Steel buy buying its CALL Option. In future, if the price rises, the premium also rises. Then you can square up (sell) the call option and book your profit to the extent of premium. It needs to be noted that the rise in premium need not be propotionate to the rise in share price.

Alternatively if the share price falls, then your call premium decreases and sometime you may lose money to the extent of the premium.

It would now be clear that you have unlimited upside potential but limited downside risk.

Types of Options:

Call option - It is the right to buy but not the obligation to sell
- Here the Profit is Unlimited
Put Option - It is the right to buy but not the obligation to sell

When you sell the call option, it is called Call writing. Here the profit is limited to the premium earned.

Methods of using options :
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Either you can BUY Call or Put Option
or
You can write (sell) Call or Put Option

Concepts to understand:
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In the Money : If the Nifty spot price increases by Rs.100, call will increase by Rs.75 to Rs.80.

At the Money : If the Nifty spot price increases by Rs.100, call will increase by Rs.50.

Out of the Money : If the Nifty spot price increases by Rs.100, call will increase by Rs.30.

In our theory we would enter the option trading "In Money or At the Money"