Options Trading & Popular Option Strategies

1. Introduction to Options Trading

Options trading is one of the most powerful segments of financial markets. It combines flexibility, leverage, and risk management tools, allowing traders and investors to protect portfolios, generate income, or speculate on market movements.

Unlike stocks, which represent ownership in a company, options are derivative contracts. Their value is derived from an underlying asset such as stocks, indices, commodities, or currencies.

An option is a contract between two parties that gives the buyer the right (not obligation) to buy or sell an asset at a predetermined price (called strike price) before or on a specific date (called expiry date).

Options are widely used in India (on NIFTY, BANKNIFTY, stocks) and globally (on S&P500, commodities, forex). Their appeal comes from:

Small capital requirement compared to stocks.

Potential to profit in bullish, bearish, or sideways markets.

Ability to create tailored strategies using combinations.

2. Basics of Options
2.1 Types of Options

Call Option (CE) – gives the buyer the right to buy the underlying at the strike price.

Used when expecting prices to go up.

Put Option (PE) – gives the buyer the right to sell the underlying at the strike price.

Used when expecting prices to go down.

2.2 Option Buyers vs Sellers

Buyer: Pays premium, has limited risk (loss = premium paid), unlimited profit potential.

Seller (Writer): Receives premium, has limited profit (premium), but potentially large risk.

2.3 Key Terminologies

Strike Price – agreed price of the underlying.

Premium – cost of buying the option.

Expiry – last date on which option is valid.

Moneyness – relation of spot price to strike price.

ITM (In-the-money): Option already has intrinsic value.

ATM (At-the-money): Strike = spot.

OTM (Out-of-the-money): Option has no intrinsic value, only time value.

3. Why Trade Options?

Options serve three main purposes:

Speculation – Traders use options to bet on market direction with lower capital.

Example: Buying NIFTY 20000 Call if expecting NIFTY to rise.

Hedging – Investors protect their portfolios using options.

Example: Buying Put options to hedge stock portfolio during uncertain times.

Income Generation – Selling options to collect premium income.

Example: Covered Call writing by long-term investors.

4. Understanding Option Pricing (The Greeks)

Option prices are influenced by several factors. The "Greeks" help traders understand risks:

Delta – sensitivity to price movement of underlying.

Theta – time decay; options lose value as expiry approaches.

Vega – sensitivity to volatility; higher volatility increases option premium.

Gamma – rate of change of Delta; measures risk in sharp movements.

Understanding Greeks is crucial for advanced strategy building.

5. Popular Option Strategies

Now let’s move into the heart of options trading – strategies.
Each strategy is designed for a specific market view: bullish, bearish, or neutral.

5.1 Bullish Strategies

Long Call

Buy a call option to profit from price rise.

Example: NIFTY at 20,000. Buy 20,200 CE for ₹100 premium.

If NIFTY rises to 20,500 → Profit = 200 points – 100 = 100 points.

Bull Call Spread

Buy lower strike call + Sell higher strike call.

Lower cost, limited profit.

Example: Buy 20,000 CE (₹200), Sell 20,500 CE (₹100). Net cost ₹100. Max profit ₹400.

Bull Put Spread

Sell higher strike put + Buy lower strike put.

Used when moderately bullish.

5.2 Bearish Strategies

Long Put

Buy a put option to profit from price fall.

Example: Stock at ₹1000, buy 950 PE. If stock falls to ₹900 → gain.

Bear Put Spread

Buy higher strike put, sell lower strike put.

Limited profit, limited risk.

Bear Call Spread

Sell lower strike call, buy higher strike call.

Used when expecting mild downside.

5.3 Neutral/Sideways Strategies

Straddle (Long)

Buy Call + Buy Put at same strike.

Profits if market moves sharply either side.

Loss if market remains flat (due to time decay).

Strangle (Long)

Buy OTM Call + Buy OTM Put.

Cheaper than straddle, needs bigger move to profit.

Iron Condor

Sell OTM Call + Sell OTM Put, while buying further OTM Call & Put for protection.

Profits in range-bound markets.

Butterfly Spread

Combines multiple calls or puts to profit from low volatility.

Example: Buy 19,800 CE, Sell 20,000 CE x2, Buy 20,200 CE.

Maximum profit if market stays near 20,000.

5.4 Advanced Strategies

Covered Call

Own the stock + Sell a call option.

Generates premium income, but caps upside.

Protective Put

Own stock + Buy a put option.

Acts like insurance against downside.

Calendar Spread

Buy long-term option, sell short-term option.

Profits from time decay differences.

Ratio Spreads

Involves selling more options than bought.

Used for advanced traders with volatility view.

6. Risk Management in Options

Options trading involves leverage and hence, strict risk management is vital:

Position sizing – never risk more than 2-3% of capital per trade.

Stop-loss levels – exit when trade goes wrong.

Avoid naked option selling – unlimited loss potential.

Understand expiry risk – options decay faster near expiry.

7. Practical Application in Indian Markets

NIFTY & BANKNIFTY Options dominate volumes in India.

Retail traders often buy weekly options for intraday or swing trades.

Institutions use option selling strategies for income.

Example: Selling weekly straddles on BANKNIFTY around events like RBI policy.

8. Pros & Cons of Options Trading
Advantages

Low capital requirement.

Multiple strategies for any market condition.

Useful for hedging portfolios.

Disadvantages

Complex pricing models.

Time decay hurts buyers.

High risk for sellers.

9. Common Mistakes by Beginners

Buying deep OTM options hoping for jackpot.

Not considering time decay (Theta).

Selling naked options without risk control.

Ignoring implied volatility.

Trading too frequently without strategy.

10. Conclusion

Options trading is not gambling—it’s a structured approach to market speculation, hedging, and income generation. Mastering options requires understanding the basics, practicing with small capital, and gradually moving into advanced strategies.

The most successful traders combine technical analysis, volatility studies, and disciplined risk management.

With experience, you’ll realize that options are like financial Lego blocks—you can build strategies suited to any market scenario. Whether bullish, bearish, or neutral, there’s always an option strategy available.