Options allow investors and speculators to hedge downside (or upside). It allows them to trade on a belief that prices will change a lot–just not clear about direction.
Two types of options
Calls = Buyer
- When you buy a call option, you're buying the right to purchase a specific security at a locked-in price (the "strike price") sometime in the future.
- If the price of that security rises, you can make a profit by buying it at the agreed price and reselling it on the open market at the higher market price.
Puts = Sell
- When you buy a put option, you're buying the right to sell someone a specific security at a locked-in strike price sometime in the future.
- If the price of that security falls, you can make a profit by buying it on the open market at the lower price and then exercising your put option at the higher strike price.
Option Sellers:
Call Sellers :-
- When you sell a call, you're essentially selling someone else the right to buy it. The premium for the option represents the option's upside potential; the downside potential is limitless.
- You want the price to remain stable (or even fall somewhat) so that whoever buys your call does not exercise the option and force you to sell.
Put Sellers :-
- You are selling the right to sell to someone else when you sell a put. The premium for the option is the upward potential, while the stock's value is the downside possibility.
- You want to keep the price above the strike price so that the buyer doesn't compel you to sell for more than the stock is worth.
Call option would be:
- In the money
- At the money
- out of the money
Options Trading
- In options trading, the buyer has a right, the seller has an obligation. An option buyer purchases the right, but not the obligation, to buy or sell the underlying futures contract at a specified price.
- For every option bought, someone has to sell that option.
The Option Seller
- A person can be an option seller (also called an option writer) who sells put or call options.
- An option seller assumes obligation when an option buyer exercises their right.
Hedging
- "Hedging" you mean "defining a maximum loss", then you would simple use some of your premium to buy an OTM put and call.
- Those who don't have time to track market regularly use hedging strategy to do option trading.
- Hedging in its literal meaning means 'to protect.'
- Option sellers use it to save capital otherwise face unlimited losses.
- If you sell call option if market go in other direction losses will be unlimited.Traders buy OTM call option to protect their capital and reduce fear of unlimited losses. Buy ITM option and sell future to hedge position.
- There are different ways to hedge an option straddle. And hedging is essentially maintaining the delta of the position. A straddle is betting that a stock price is either going to fluctuate strongly (up or down, you don’t care which) and a short straddle is betting the stock price will not go up or down more than the total of both options you sold.
Straddle
- A straddle is an options strategy involving the purchase of both a put and call option for the same expiration date and strike price on the same underlying.
- The strategy can be profitable when the stock either rises or falls from the strike price by more than the total premium paid.
- Even though it is effectively a directional bet, because it is agnostic to which direction and because it involves both an ATM call and put, it is also delta-neutral at initiation of the strategy.
- A straddle in option means buying/selling options contract at the same strike .
There are two types of straddle , short straddle and long straddle.
Short Straddle:
Selling options contract at the same strike.E.g.. Suppose nifty is trading in 19500 ,than you can create short straddle by selling 19500 PE and 19500 CE( Here PE stands for Put and CE Call)
Long straddle:
Buying options contract at the same strike.E.g.. Suppose nifty is trading in 19500 ,than you can create long straddle by selling 19500 PE and 19500 CE.
Strangle
Strangle is a volatility trading strategy. It involves buying or selling a pair of a call and a put option which are slightly Out of The Money (OTM).Long Strangle
Long Strangle is one of the most popular Options trading strategy that allows the trader to hold a position in both call and put with the same expiration cycle but with the different strike price.