What is Options Trading?

Options trading is slightly different from traditional equity trading or trading in stocks. Unlike stocks that are bought and sold on a daily basis, Options are mere contracts. These are exchanged with a promise to exchange the underlying on a future date. The value of these options contracts is determined by multiple factors like Options Greeks and volatility. The price at which these options contracts are exchanged is known as Premium.

Options trading is also one of the quickest ways to lose money in the stock market. By spending a very small amount you can earn very big profits. As an option buyer you pay money for the premium. So, if you incur losses you will lose the premium money. On the other hand, option sellers have a very huge margin. Here is a simple example:

Option buyer is willing to sell premium of Rs.5000. Here the maximum money that seller can make is the premium i.e. 5000/- only. Let’s say in the future this premium amount rises to 50,000/-, then the seller will lose this entire margin if he doesn’t execute the trade. So, for sellers there is an option to sell later considering the margin.

Types of Option Trading

Options are typically traded by two sets of people. One represents the Options buyer and the second is the option seller.

1. Option buyer

The buyer of an option pays an upfront premium for the options contract and either sell it on a later date or holds it till expiry. Within this duration, the buyer of the option can make a gain by selling the option at a higher price or incur a loss. In option buying, the maximum amount of risk is the total amount of premium paid by the buyer. Whereas the maximum profit is uncapped. Although the option buyer enjoys limited risk and unlimited reward, the probability of profits is extremely low.

2. Option seller

The option seller receives the premium paid by the option buyer. A seller of an options contract carries limited profit and unlimited risk. The maximum profit is the total amount of premium collected whereas the maximum loss is uncapped here. However, in options selling, the seller enjoys certain benefits like the Time decay (Theta Decay) which increases the probability of profits.

How much money is required for Options trading?

Now that you know the 2 aspects of options trading, the next question is, how much money do I require to start options trading?

Option Buying

Let's first start with the more exciting approach of options trading which is Options buying. To buy an ATM (At The Money) Index (Nifty) option, you will require anywhere between Rs 7,000 to Rs 20,000 per lot, depending on the expiry. A weekly index option will require somewhere around Rs 7,000 which will keep on decreasing as you move closer towards the expiry. Similarly, a monthly index option will require around Rs 15,000 to Rs 20,000 at the beginning of the month. A stock option will cost around Rs 25,000 to Rs 30,000 depending on the stock and time to expiry.

Option Selling

Secondly, Options selling requires significantly more capital when compared to option buying. To sell a weekly index option, you will require around Rs 95,000 and a monthly option will require almost the equivalent amount for one lot. The higher margin requirement is to ensure the safety of the option traders in case of an MTM (Mark to Market) loss.

In case you want to sell a stock option, you will have to pay around Rs 1,30,000 to Rs 1,50,000 in margin for 1 lot.

Hedged Option Strategies

However, there are some ways to reduce the overall margin requirement and also the risk. By taking hedged positions or a combination of both option buying and selling, you can reduce the overall money to initiate the trade. To implement a hedged strategy like an Iron Condor or Iron Butterfly, you will require around Rs 30,000to Rs 45,000 in 1 Lot in Nifty or Bank Nifty options. With a combination of option buying and selling, you will be able to increase your profitability and simultaneously decrease the maximum risk.