We will be updating this section with stock for the month for swing trades. It will also explain in detail the reason for picking it and risk to reward ratio. We will also upload an excel sheet with returns and loss updated and other details, which will in a way act as a trading journal.
What is value of options? Why is it important?
Options are the derivatives of the Stocks or Index such as NIFTY or NIFTY BANK which are traded by the Stock Exchanges NSE and BSE. So, the value of the options is derived from the value of the underlying asset. The value of an option is the current market price of that option at which is being traded in the stock market. Its value depends on various factors, but more importantly there are two major factors which govern the value of an option, they are –
- Intrinsic Value
- Time Value
To understand the two terms in detail, we need to take an example in real scenario. Let us take the NIFTY 50 Index which is trading at 14,677.80 as on May 14, 2021. It is the benchmark index of NSE having the market value of the top 50 companies having highest market capitalization. Market cap means the total number of shares of the company multiplied by the share price.
|Strike Prices||14000 CE||14600 CE||15000 CE|
|Total Premium (May 27 2021 expiry)||752||277||81.50|
The data in the green color can be found from the NSE Option Chain website (https://www.nseindia.com/option-chain) or from any brokers’ trading platform.
Intrinsic Value is the difference between the Current Value of the Underlying Stock/Index (NIFTY 50 index here) and the strike price of that option. It can never be in negative, either it is positive or zero.
Time Value is the difference between the total premium value and the intrinsic value of the option.
From the table, we can summarize,
- The intrinsic value of the option decreases as we move above the current price of the underlying asset and increases as we move below the current price.
- The time value is maximum at the current market price and it decreases on the either side.
The Time value signifies that how much time is left from the date of expiry in terms of value. As the time will pass, the time value will go on decreasing and at the end of expiry, the time value will decay down to 0 and only the intrinsic value will remain as the total premium value.
Classification of Options based on Intrinsic Value –
- ITM Option:- ITM option stands for In the Money Option. It means the strike price of the option is less than the Current Price of the underlying stock/index for a Call Option and it is more than the current price for a Put Option or in other words, the intrinsic value is not equal to zero. For Ex – If Nifty is trading at 14600, So all the call options with Strike Prices lower than 14600 are ITM options and all the Put Options of strikes higher than 14600 are ITM options.
- ATM Option:- ATM option stands for At the Money Option. It means the strike price of the option is equal to very close to the current price of the underlying stock/index for both the PE and CE options. In above example, 14600 CE and PE option will be ATM options.
- OTM Option:- OTM option stands for Out of the Money Option. It means the strike price of the option is more then the current price for a Call option and lower than the current price for a Put Option. Again, for above example, all call options with strike prices more than 14600 are OTM and all put options with strike prices lesser than 14600 are OTM.
Nothing in the world comes for free. It has some premium!!
Each one of you must have sometimes heard the term ‘insurance’ in your life from your parents, friends, teachers, relatives and most importantly family doctors who usually advise you to take health insurance. Even if you have not heard, there is nothing to be worried off, or go up and look in the dictionary, after reading this page you will get to know what is insurance and how it is related closely to the term Options in Stock Market.
Insurance basically is a security for your health, life, diseases, accident and can be of very general things like, theft security, fire security etc. It is important so that during an unfortunate happening like a death or an accident, you don’t need to worry about the finances you require for your treatment or supporting your kith and kin and your savings will not be encroached. In order to get an insurance, what do you pay the company? It is the premium that you pay every year, quarter or monthly as per your choice and financial stability. And the company will issue you the policy with the benefits.
Now, you must be wondering, am I here to talk about the Options or Insurance Policies? But, this background was required to establish a close relation between Options and Insurances. Up till now, how the insurance works for an individual who is buying the policy from a company. This is similar to buying an option in the stock market. Now, let us see how this is profitable for the company who is selling the policy. Basically, the company issues policy to a wide range of customers and collects premium from them every year. It reinvests the amount collected in the Equity Markets for a better return of investment. And it is hardly 0.1% of the total customers who claim the amount from the insurance company at dreadful times. So, in this way the company runs profitably. This is similar to selling an option in the stock market.
So, Options are securities which you Buy/Sell in the stock market and pay/collect premium from the opposite party so that when the maturity of the option is arrived, either the buyer of the option gets a chance to claim from the seller or the seller wins the premium if the claim is not successful.
There are two types of options which are traded by the NSE (National Stock Exchange) in the market. They are -:
- Call European (CE)
- Put European (PE)
Let us see them in detail-
Call European (CE): Call Option means the buyer has the right to buy with no obligation to sell and the seller of the call option has and obligation to sell. Before going into the details, we first need to understand some basic terms related to options.
- Strike Price : This is the price which is close and comparable to the actual spot price of the stock.
- Expiry Month : It is the date of expiry of the option similar to the maturity date of an insurance policy. It means you can buy/sell this option before this expiry ends and after that you can exercise the claim of this option if the condition arises. For stock options, they expire on the last Thursday of every month unless there is a national/gazette holiday.
- Premium Per unit : It is the amount of premium that you have to pay at the time of buying the option or you get at the time of selling an option.
Let us see an example of what does exercising an option claim means –
The current market price of Reliance Industries Ltd is Rs. 1937/ share. If an individual buys a Call option of Reliance 2000 strike price of May month expiry at a price of Rs. 17.80 per unit. Generally, options and futures are traded in lots of fixed sizes. So, for Reliance Industries, you have to buy a minimum of 250 units if you trade in futures or options.
When you buy a call option of 2000 strike price, it means that you are having a bullish view for the stock and believe that the stock price will cross Rs. 2000 mark at the end of May month expiry. So, there can be three scenarios,
- If the price is below 2000 at the end of expiry à In this case, the value of the 2000 CE option will go down to Rs. 0.00 and whatever premium the buyer has given at the time of buying the option has matured without receiving any claim from the seller because the condition is not fulfilled and the buyer will be at loss and the seller has win the total premium.
- If the price is above 2000 but below 2017.80 à In this case, the value of the option will be equal to the difference between the price of the stock at the end of expiry and 2000. Again here, the buyer will be at some loss and seller will be at some profit.
- If the price is above 2017.80 à In this case, the value of the option will be equal to the difference between the price of the stock at the end of expiry and 2000. Now this time, the buyer will be in profit and the seller will be in loss. Here, the buyer can either exercise the option by claiming the right to buy the shares of Reliance Ltd. at the price of Rs. 2000/share (minimum 250 qty needs to be bought) even though the current market price is more than 2017.80 and the seller will have an obligation to sell the stock at Rs. 2000/share or the buyer/seller can close their option trades without going into physical deliveries of stocks.
Summarizing in a table,
Put European (PE): Put Option means the buyer has the right to sell with no obligation to buy and the seller of the call option has an obligation to buy. Let us take the same example of Reliance Industries with a put option this time.
If an individual buys a PUT option of Reliance 1900 strike price of May month expiry at a price of Rs. 21.10 per unit, it means that he/she is having a bearish view for the stock and believe that the stock price will go down below 1900 mark at the end of May month expiry. So, there can be three scenarios again,
- If the price is above 1900 at the end of expiry à In this case, the value of the 1900 PE option will go down to Rs. 0.00 and whatever premium the buyer has given at the time of buying the option will be matured without receiving any claim from the seller because the condition is not fulfilled and the buyer will be at loss and the seller has win the total premium.
- If the price is below 1900 but above 1879.90 à In this case, the value of the option will be equal to the difference between 1900 and the price of the stock at the end of expiry. Again here, the buyer will be at some loss and seller will be at some profit.
- If the price is below 1879.90 à In this case, the value of the option will be equal to the difference between 1900 and the price of the stock at the end of expiry. Now this time, the buyer will be in profit and the seller will be in loss. Here, the buyer can either exercise the option by claiming the right to sell the shares of Reliance Ltd. at the price of Rs. 1900/share (minimum 250 qty needs to be sold) even though the current market price is less than 1879.90 and the seller will have an obligation to sell the stock at Rs. 1900/share or the buyer/seller can close their option trades without going into physical deliveries of stocks.
Hope you liked reading the page. Comment for any doubts or queries.
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