Trading in Options

Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security. For example, buying a "call option" provides the right to buy a specified quantity of a security at a set strike price at some time on or before expiration, while buying a "put option" provides the right to sell. Upon the option holder's choice to exercise the option, the party who sold, or wrote, the option must fulfill the terms of the contract.

Options can be effectly used to hedge the potential losses for the shares that we are holding . In F&O segment all the shares are traded in specific amount of quantities(or lots) so any transation can be done in that amounts only. There are two types of options call option which gives right to buy and put option which gives right to sell. I will explain put option as a hedging tool.

if you are are holding 700 RCOM shares and you want to insure the profits of that you can buy a put option for that for the specified month.
The important things in options are strike price which indicates price of the share( for selling ) and premium which we need to pay for that contract and expiry date which indicates the date of the expiry .

If the pirce of RCOM in cash market say 650 on 1st Jan . We can buy a put option for the series (which expire on last thursday of the month) of strike price 650 for a primium say 20 rs , by paying 14000(20*700) . We can execute the option anytime before the end of the month. By the time of expiry if the price goes up you will loose the premium amount ( but the same amount we will gain in cash market) . If the market crash in the middle of the month we can execute our right to sell at 650 and we can make money, If the price of the share say 640 we will loose 10rs of our premium money and we will get the remaining money back.

This is a general senarios , what we can do is , if we can identify some share which can outperform the index , for example buy a nifty share in cash market and buy a put options for nifty then the possibility of losing money will be minimal..

Note: Buying a put option without holding the share is too risky and not advisable ( especially in a bull market like india).

Call option will work in same way but gives right to buy the share..

RK